Real Estate Bubble

NEWS: Housing-Bubble Talk Doesn't Scare Off Foreigners

2005-08-24T06:53:00.000-07:00

Global Investors Gobble Up Mortgage-Backed Securities, Keeping Prices Strong

By RUTH SIMON, JAMES R. HAGERTY and JAMES T. AREDDY

Staff Reporters of THE WALL STREET JOURNAL

August 24, 2005; Page A1

Strong demand for mortgage-backed securities from investors world-wide is allowing American lenders to make more loans -- and riskier ones -- in a way that is helping prolong the boom in U.S. house prices.

The cash pouring in -- not only from U.S. investors but increasingly from Europe and Asia -- keeps stoking the housing market even as the Federal Reserve Board continues to raise interest rates, normally something that damps home prices. The market has shown a few signs of slowing recently, and talk of a bubble has grown louder, but prices continue to rise or remain at lofty levels as investors continue to gobble up mortgage-backed securities and banks keep lending.

"As the Fed has tightened, lenders have eased" terms for borrowers, says Mark Zandi, chief economist at Economy.com, a forecasting firm in West Chester, Pa.

Investment banks and other firms have been buying mortgage loans from lenders and packaging them into securities for sale to investors since the 1980s. But investor demand has surged in recent years, largely because in an era of low returns, mortgage-backed securities offer yield-starved investors much higher returns than government bonds.

U.S. lenders will make about $2.8 trillion in home-mortgage loans this year, according to the Mortgage Bankers Association. The MBA estimates that about 80% of these loans will end up in mortgage-backed securities. Mortgage-backed securities outstanding at the end of the first quarter totaled $4.61 trillion, up 61% since the end of 2000. In the same period, total Treasury securities outstanding grew 35% to $4.54 trillion.

[riskier loans graphic]

Investors' strong demand for mortgage debt, besides allowing lenders to offer many borrowers better terms, has also made it easier to offer mortgages to borrowers who might not easily qualify for a loan. The growth of the mortgage markets spreads the risks around. But some mortgage-industry analysts say lenders have become less stringent in their loan terms because they can sell almost any type of loan to those who package mortgage securities for investors.

"Loose lending standards are probably the single biggest thing fueling the speculative fever we have today" in housing, says Kenneth Rosen, an economist who is chairman of the Fisher Center for Real Estate at the University of California at Berkeley.

In a world of low interest rates, the market for mortgage securities is simply too big and profitable for many investors to ignore. Investors can earn about 5.5% on mortgage securities whose payments are guaranteed by Fannie Mae or Freddie Mac, government-sponsored companies. Those who can stomach greater risk can buy subprime mortgage securities, which come with no guarantee but can yield as much as 15%, according to Bear Stearns. By contrast, 10-year U.S. Treasurys yield about 4.2%; the equivalent government securities in Germany yield about 3.2% and in Japan 1.5%.

The buyers of mortgage-backed securities include U.S. pension funds, hedge funds and insurance companies. But overseas investors are the fastest-growing source of demand. The trade publication Inside MBS & ABS estimates that foreigners held $280 billion of U.S. mortgage securities at the end of 2004, or 6% of the total outstanding. The foreigners' holdings rose 26% last year and have continued to bound ahead so far this year, Inside MBS & ABS says.

"There's this insatiable appetite for mortgage-backed securities world-wide," says Andrew Sciandra, a senior vice president at IndyMac Bancorp, a California thrift, who heads a team that creates those securities. In the past year, Mr. Sciandra has met with investors from places like Germany, France and Abu Dhabi. Asian investors now account for roughly 10% to 20% of mortgage securities sold by IndyMac.

For homeowners, the growing international demand for mortgages means it's increasingly likely that the money they borrow to buy a home or refinance their mortgage is coming ultimately from outside the U.S. When Claude Gaty, a chef and co-owner of a bistro in Las Vegas, recently refinanced the mortgage on his four-bedroom Las Vegas home, the lender was IndyMac. But the bulk of the money came from investors in Asia.

IndyMac pooled Mr. Gaty's loan with about 3,000 other mortgages that carry a fixed rate for the first three, five or seven years. Mr. Gaty is paying both principal and interest on his loan, but most of the loans in the pool are interest-only mortgages, which allow borrowers to pay no principal in the early years. When the $650 million offering of triple-A rated bonds backed by these mortgages came to market in June, it drew more than a dozen investors from Europe, Asia and the U.S., according to Deutsche Bank, which handled the deal. Such bonds typically yield 0.75 to 1.15 percentage point more than Treasurys, Deutsche Bank says.

The most recent entrant to the market is China. Its banks are rich with deposits from Chinese companies that earn dollars exporting to the U.S. Dollars have also been handed to some banks by the government in Beijing as part of its efforts to strengthen their balance sheets.

Until a few years ago, Chinese investors restricted U.S. investment mostly to Treasurys. Now, to boost their yields and because they consider the market safe, bankers from a number of institutions say they are devoting more of their portfolios to mortgage securities. Some bankers say their goal is to have 40% of their U.S. dollars in asset-backed securities.

China's government also is testing U.S. mortgage investment. The country's Bank of Communications, the only bank with a mandate to help manage China's $700 billion of foreign-exchange reserves, has recently put a sliver of those reserves into mortgage-backed issues, according to a banker there. The State Administration of Foreign Exchange, the government agency in charge of the reserves, declined to comment.

Zhu Kai, who helps manage U.S. dollar investments at Bank of China, says in a rare interview that his mortgage-backed portfolio has "plenty of room to grow." Mr. Zhu expresses confidence in the U.S. dollar and the health of the U.S. home market. Housing is so vital to the U.S. economy, Mr. Zhu and some of his counterparts at other Chinese banks reason, that U.S. authorities will prevent a bust.

Even the recent decision by the Chinese government to raise the value of its currency by about 2% isn't likely to lead Chinese banks to shift their plans. "The timing may be a little bit surprising but we will not change our investment portfolio," Mr. Zhu says.

While Asian investors have largely focused on triple-A-rated bonds, other investors are buying lower-rated debt. These bonds, which are created when bankers carve up pools of mortgages, offer higher yields, but also bear the first risk of losses should borrowers default. Investors who buy these bonds in effect set the standards for which mortgages are made by deciding how much extra yield they need to compensate for the added risks of lower-quality loans. They include real-estate investment trusts, hedge funds and investors from Europe.

Strong investor interest has also made loans available to borrowers with poor credit and many other people who might otherwise have trouble getting a mortgage. Subprime loans included in mortgage securities totaled $401.5 billion last year, nearly double the total for 2003, according to Standard & Poor's. Meanwhile, loans with less than full documentation of the borrower's income and assets accounted for 70% of mortgage securities rated by Standard & Poor's in this year's first half, double the level recorded in 2000.

"There's no question that [lending] standards have loosened over the past couple of years," says Arthur Frank, director of mortgage research at Nomura Securities International in New York. If house prices fall, "you may well have some pretty serious credit problems," hurting holders of the lower-rated mortgage securities.

Mr. Zhu, the Chinese fund manager, is sanguine, for now. The U.S. housing market is "maybe losing a bit of steam," Mr. Zhu says. "I think the monetary authorities, they don't want this housing market to burst. I don't think it is a bubble. But if things go on like this for another five years, it's a different story."

NEWS: Bankers' Group Issues A Caution on Home Loans

2005-08-24T06:51:00.000-07:00

By JAMES R. HAGERTY

Staff Reporter of THE WALL STREET JOURNAL

August 24, 2005; Page D3

The Mortgage Bankers Association, whose members have been promoting home loans with low initial repayments, urged consumers to choose such loans with care.

"Borrowers need to be vigilant to be sure that they are prudently measuring and managing" the added risks many accept by embracing loans that minimize monthly payments in the early years but can require much-higher payments later, the trade group said in a 30-page report released yesterday.

The report comes in the wake of recent warnings from Federal Reserve Chairman Alan Greenspan, bank regulators and the National Association of Realtors about the risks of such loans.

The mortgages in question include interest-only loans with rates that adjust periodically based on prevailing rates. With these loans, borrowers pay only the interest due during an initial period, often five years. Monthly payments then rise steeply as the borrower begins paying off the principal. Borrowers could face a double payment shock if the onset of principal payments coincides with a rise in interest rates.

Critics also have raised questions about the risks of "payment-option" loans. These loans give borrowers several payment options each month, including one that falls short of the interest due. When borrowers select that option, their loan balances increase -- something known among mortgage bankers as "negative amortization."

These loans are especially popular in California and other places where home prices are surging. The mortgage bankers' report said that these "innovative" mortgages help more people become homeowners. Still, the rising popularity of interest-only and payment-option loans exposes borrowers to "potentially substantial payment shocks," the report said.

Mitigating those risks, the report said, is an improving job market, which means more consumers will be able to afford higher loan payments. In addition, the report said, "there is only a small percentage of borrowers that are potentially vulnerable to an increase in [interest] rates or other economic shock." The report cited a Census Bureau survey showing that 35% of homeowners don't have any mortgage debt and an additional 50% have fixed-rate loans.

Competition among lenders, however, has spurred some of them to take more risks. Ameriquest Mortgage Co., Orange, Calif., one of the nation's largest home lenders, until last year avoided offering interest-only loans to subprime borrowers, those with blemished credit histories.

Spurred by rivals who were using interest-only loans to gain market share, however, Ameriquest began offering them to some subprime borrowers earlier this year. "We take what we consider a prudent approach to serve the interests of both our borrowers and our investors," an Ameriquest spokesman said. "We restrict interest-only loans to owner-occupied properties and require our interest-only borrowers to have higher credit scores."

Investors Fret Mortgage Balloons Will Burst

2005-07-27T05:23:00.000-07:00

By JESSE EISINGER
July 27, 2005; Page C1

There has been plenty of talk about a housing bubble, but very little about a mortgage bubble.

Now investors are starting to see worrisome signs in some banks' latest quarterly earnings reports. In others, such signs are absent. Good news? Nope, because disclosure is so poor at so many banks.

As home prices have soared, banks have been enticing customers with sweet-sounding mortgages that lower monthly payments, including interest-only loans. The most dangerous development is mortgages that offer payment options.

Typically, these so-called option adjustable-rate mortgages, or option ARMs, let customers choose how much to pay each month. They can make the standard principal-and-interest payment or pay just the interest. And then there's the even dicier option to make just a low minimum payment, as with a credit-card bill.

Hey, when there are Escalades to buy and home prices are always rising, you really have to learn to stop worrying and love that minimum payment. The catch is that the unpaid portion of the interest gets tacked onto the principal -- a "negative amortization" that increases the size of the mortgage. Left with more debt, the customer is more vulnerable to rising rates.

These products are advertised in misleading ways. Banks pitch that customers can pay back the loan at a rate of, say, 1%. But that's just the rate used to calculate the minimum payment in the first year, not the actual underlying rate. The rising popularity of option ARMs concerns some prudent banking executives, including Golden West Financial's Herb Sandler, who runs the midsize bank with his wife and sells plenty of the mortgages. Some lenders "are clearly faking their borrowers out," he says.

Along with Golden West, publicly traded lenders with big exposure to these products include Countrywide and Washington Mutual and smaller California banks such as Downey, First Fed and Indymac. Golden West has been selling them for 25 years and has a solid track record with them, even in recessions and rising-rate environments. When fully explained to the right customers, such as a Porsche salesman who makes plenty each year but doesn't know how much he'll score from month to month, "it's a terrific borrower loan," says Mr. Sandler. "We have never had a delinquency, much less a foreclosure, due to the structure of the loan."

But some banks are lowering their credit standards, sometimes qualifying borrowers based on their ability to make the minimum nut, not whether they can afford the whole deal. "That is an outrage," Mr. Sandler says.

Option ARMs are wonderful not just for borrowers who can't afford their houses, but also for investors who look only superficially at a bank's earnings report. A bank books the entire amount that a customer owes as income each month, not the minimum payment that's actually paid. Voilà, noncash earnings.

It gets better: The unpaid interest gets tacked on to the bank's outstanding loan total, allowing the bank to display loan growth, which investors love. "You get earnings and growth. What more can you ask for?" says Keefe, Bruyette & Woods analyst Fred Cannon.

But there could be credit problems down the road. And at some point, it's plausible regulators might fret about the bank's capital.

Last week, Golden West's stock took a hit after it disclosed how much its exposure to option ARMs has increased. The company reported that $160.2 million of its loans was actually unpaid interest tacked on to borrowers' principal -- that negative amortization I mentioned. That's a huge leap from last quarter's $90.2 million and $27 million in last year's second quarter.

The company reassures investors that the total is a mere 0.14% of its loans. But as a percentage of net interest income, the $70 million change in the negative amortization figure was 10% in the second quarter, compared with 5% in the first quarter and practically nothing a year ago, says Mr. Cannon.

Mr. Sandler says Golden West's lending practices are disciplined, so it won't get into trouble. The only risk, he concedes, is that home prices decline broadly, in which case all mortgages suffer, regardless of structure.

But good companies are often undermined by the irrational practices of competitors. It's not quite fair of me to pick on Golden West. I do so only because it fully discloses its exposure.

Other major banks are more reticent. Washington Mutual disclosed some aspects of its exposure for the first time this quarter, but left questions unanswered, says Mark Agah, analyst for independent research firm Portales Partners. It originated $19.6 billion of option ARMs in the second quarter, or 37% of its home-loan volume. WaMu didn't report the total amount of deferred interest beefing up its loan totals. Instead, it said option ARM borrowers' principal had grown by $26 million, or 0.04% of outstanding balances. That doesn't count all the deferred interest from borrowers who paid down their principal for a time but then started making minimum payments. Washington Mutual actively sells most of its option ARMs into the secondary market, but that market might not always be available on attractive terms.

A WaMu spokeswoman says in an email that the company is considering how best to disclose option ARM data.

Countrywide discloses even less. It says its second-quarter ARM volume was $67 billion, or 56% of its home-loan volume. But the company didn't disclose the percentage of option ARMs in its financial statements and doesn't disclose the amount of negative amortization. In response to questions from investors during its earning conference call yesterday, the bank said that 20% of its loan production this year has been option ARMs, at least 50% from California. Countrywide said on the call that it, too, planned to increase disclosure.

What should investors do? Problems won't come today or tomorrow, but don't look now: Rates, they are arisin', and that's when some borrowers will run out of options. At least investors still have some options left. Like reducing their exposure to mortgage banks.

NEWS: Mortgage Lenders Loosen Standards

2005-07-26T05:50:00.000-07:00

Mortgage Lenders Loosen Standards
Despite Growing Concerns, Banks Keep Relaxing Credit-Score, Income and Debt-Load Rules

By RUTH SIMON

Staff Reporter of THE WALL STREET JOURNAL

July 26, 2005; Page D1

Mortgage lenders are continuing to loosen their standards, despite growing fears that relaxed lending practices could increase risks for borrowers and lenders in overheated housing markets.

Novel loan products have helped fuel much of the run-up, which continues to defy expectations, as reflected in home-sales data released yesterday. Existing-home sales hit another record in June, up 2.7% from May's heated levels, according to the National Association of Realtors. Median home prices rose 14.7% from June 2004.

But lenders are making it still easier for borrowers to qualify for a loan. They are lowering the credit scores needed to qualify for certain loans, increasing the debt loads borrowers can carry and easing the way for borrowers to get loans while providing little documentation. In some cases, lenders are easing standards not only for homeowners, but also for the growing number of people buying residential real estate as an investment.

In one recent move, Chase Home Finance, a unit of J.P. Morgan Chase & Co., this spring began allowing some of its customers to take out home-equity loans and lines of credit without having their incomes verified. Under the new program, income verification isn't required for home-equity loans of up to $200,000, provided that the borrower's total mortgage debt doesn't exceed 90% of the property's value or $1.5 million. The change "is not for all customers -- it's only for customers with the very highest credit rating," a company spokeswoman says. Loans with little or no documentation have grown in popularity industry-wide.

Last month, Wells Fargo & Co. began allowing buyers of investment properties in some parts of the country to take out interest-only mortgages, which let borrowers pay interest and no principal in the loan's early years. Another recent change in some markets boosts the standard for how much total debt and housing expenses certain borrowers can carry to 45% of their income from 38%.

A Wells Fargo spokesman says the company doesn't discuss specific changes, but that it consistently monitors economic conditions in its major markets and will at times "modify our lending guidelines in a specific market." He added, "On a national basis, we have made no substantive changes to our lending policies and practices."

Banking regulators, meanwhile, are paying closer attention to mortgage lending practices. "Lending standards are continuing to ease," says Barbara Grunkemeyer, deputy comptroller for credit risk at the Office of the Comptroller of the Currency, which is putting the finishing touches on its annual survey of bank underwriting standards. Federal Reserve surveys of bank loan officers show that lenders have tended to loosen standards since early 2004, following a period of relative tightening.

In some cases, lenders have tweaked their offerings by reducing the minimum credit scores needed to qualify for certain loans. Countrywide Financial Corp., for instance, recently cut by 20 points the minimum credit score borrowers with bigger loan amounts need to qualify for one of its popular loan programs. A Countrywide spokeswoman says the change was designed to make the terms of this loan consistent with its other offers.

The continuing loosening of lending standards has helped push the homeownership rate to a record 69% of U.S. households. Mortgage delinquencies, meanwhile, have remained low, with just 1.08% of residential mortgages in foreclosure proceedings at the end of the first quarter, down from 1.17% five years earlier, according to the Mortgage Bankers Association. Low interest rates and rising home prices have helped keep delinquencies down by keeping monthly payments in check and making it easy for borrowers who run into trouble to refinance or sell their homes at a profit.

But the lowering of standards has also raised concerns that some borrowers may run into trouble making their payments, and that defaults could rise. In May, in response to concerns about looser underwriting standards, bank regulators issued their first-ever guidelines for credit-risk management for home-equity lending. Regulators are working on new guidelines for mortgage lenders.

In addition, bank examiners "are looking more at how banks originate first mortgages today than they were a year ago," says Ms. Grunkemeyer of the Office of the Comptroller of the Currency. "The reason they are doing it is because the mortgage products [lenders] are originating are higher risk."

Washington Mutual Inc. says it's loosening its guidelines on some products while tightening them on others. In June, it began offering home-equity lines of credit to borrowers who buy condominium units as an investment or as a second home. Another recent change lets borrowers who buy a second home or investment property finance as much as 90% of the home's value, up from 75%. Sales of investment properties have surged recently, adding fuel to the heated housing market.

The Seattle-based lender says it has also moved to toughen some standards. Earlier this year, Washington Mutual began setting stricter limits on the size and loan-to-value ratios for loans above $7 million. It is also reassessing its credit standards for investment properties and second homes, says Jim Vanasek, the company's chief enterprise risk-management officer.

"There's been a growing awareness over the past six to nine months that the risks are starting to increase with the very, very rapid price escalation we have seen," Mr. Vanasek says. "I would be surprised if mortgage lenders don't do some degree of reining in or tightening over the next several months."

So far, evidence of tightening has been hard to detect. "The trend toward relaxing standards is still relatively strong," says Gibran Nicholas, a mortgage broker in Ann Arbor, Mich. Mr. Nicholas expects this pattern to continue as long as foreclosure rates remain low and demand remains high from investors who buy bonds backed by pools of mortgages.

Some lenders say they are being forced to relax their standards to remain competitive. U.S. Bank Home Mortgage, a unit of U.S. Bancorp, says interest-only mortgages and loans with less-than-full documentation now account for about 10% of its business, up from just 4% a year ago.

"We're just offering the product that a lot of our competitors have offered," says U.S. Bank President Dan Arrigoni. "If anything, we have to think about loosening them if we want to compete." But, he says, U.S. Bank has resisted pressures to offer increasingly popular option adjustable-rate mortgages -- which carry starting rates as low as 1% and give borrowers multiple payment choices -- because the bank considers them too risky.

Lenders also say that advances in technology and data analysis enable them to do a better job of determining who is a good credit risk. "One of the things that is often missed is that we've become much better predictors of loan performance with automated underwriting systems and appraisal practices," says Jerry Baker, president and chief executive of First Horizon Home Loan Corp., a unit of First Horizon National Corp.

First Horizon recently reduced the credit scores and boosted the loan-to-value ratio allowed on limited and no-documentation loans that it sells to investors through Wall Street. The bank says such loans represent a tiny portion of First Horizon's volume.

The loosening of standards also shows up as products that were initially geared toward the most sophisticated borrowers -- such as option ARMs and interest-only loans -- have become more mainstream. A recent analysis by UBS AG shows that the average credit scores for borrowers with option ARMs has declined over the past three years. In addition, more than 22% of the borrowers who took out option ARMs this year financed more than 80% of the purchase price, up from 12% of borrowers in 2004 and less than 2% in 2002, according to the UBS analysis, which looked at loans sold to investors.

Similarly, interest-only mortgages, which were first aimed at wealthy borrowers, are increasingly being offered to people with poor credit. Interest-only mortgages accounted for 30% of the subprime loans originated in April, according to UBS, up from 14% in all of 2004. Average credit scores and other measures of credit quality have also been declining, according to UBS.

REPORT: Real Estate Indicators and Financial Stability

2005-07-08T09:12:00.000-07:00

BIS Papers No. 21, April 2005

The papers in the volume are grouped into broad thematic areas as they were discussed in the conference: review of the impact of real estate on monetary and financial stability, usefulness of available statistics, country experiences in the compilation of real estate price indices, methodological issues on residential and commercial real estate prices, hedonic real estate price indices, aggregation issues, valuation of real estate in special situations, and areas of future work. The volume also contains a summary of the discussion that took place at the conference on possible future areas for work. Transcripts of the discussions during the individual sessions of the conference are available upon request.

[MORE]

Flipping Exchange

2005-07-07T12:02:00.000-07:00

By Matt Reed, USA TODAY

Converted apartments aren't the only hot spot in the nation's booming condominium market. In rapidly growing South Florida, new condos are traded almost like a commodity.

Entrepreneurs have launched two online exchanges where visitors can buy, sell and "flip" condos in a global marketplace.

"Condos are more and more being bought sight-unseen, based on price per square foot and the view," says Richard Swerdlow, CEO of United States Condo Exchange, or USCONDEX.

In the Miami area alone, developers have proposed as many as 70,000 units in glossy towers to be built in the next two to four years. The Web sites aim to move them in bulk, collecting commissions along the way:

USCONDEX.com. This Web site charges developers $2,500 per building per month to showcase existing and preconstruction condos. Potential buyers can search listings from West Palm Beach to Miami and negotiate online. This year, the site will launch live auctions, similar to eBay.

CondoFlip.com. This site helps buyers of unbuilt Miami condos find secondary buyers so they can sell the condos at a higher price, or "flip" them.

In a flip, the first buyer pays a deposit and signs an agreement with a developer to close on a condo when it is finished, sometimes a year or two later. As construction proceeds, the condo's value rises, new buyers want in and the original buyer can sell the unit for a profit moments after closing. Sellers pay a 4% commission for help brokering a flip.

Condo Flip founder Mark Zilbert says flipping can't work like day trades or commodity deals, when instant transactions happen online. Florida law requires contracts and paperwork to be signed and officially recorded.

Reed reports daily for FLORIDA TODAY in Melbourne, Fla.

NEWS: Renters must choose: Buy or goodbye

2005-07-07T12:00:00.000-07:00

By Charisse Jones, USA TODAY

SAN DIEGO — For James DeForest, the transformation of his rented apartment into a condominium for sale offers a chance at the American dream.

"I called my mom and dad ... and let them know I could be a homeowner out here in California," says DeForest, 48, an operations coordinator for a Bed Bath & Beyond store, who hopes to buy his bungalow unit and carry a mortgage for the first time. He expects to pay at least $300,000.

For Valerie Shield, an elementary school principal in a different pocket of San Diego, the planned conversion into condos of an apartment complex where 75 of her students live means something less rosy: Many of their families will have to find new places to live.

"These are people cleaning hotel rooms, busing tables," she says. "They can barely make the $900 to $1,000 rent. ... I'm worried about the children."

Condo conversions such as these in San Diego's stratospheric housing market are gaining momentum in metropolitan areas around the nation. In places such as Miami, Las Vegas, Charlotte and Washington, D.C., developers are buying and renovating apartment buildings, then selling the units as condominiums.

The condos, often priced far less than new condominiums or single-family homes, offer some longtime renters a fleeting chance at homeownership. Tenants who can't scrape together a down payment or obtain financing must move.

"Conversions create opportunities for entry-level purchases," says Gabe del Rio of Community HousingWorks in San Diego, which helps low- and moderate-income families. "Then we also see the other side. These are the very low-income individuals who have usually been in that complex for a very long time. ... They don't have many options."

The rental-to-condo rush is particularly hot in Las Vegas, the nation's fastest-growing metro area. Ten thousand to 13,000 apartments were converted to condominiums last year in Clark County, which includes Las Vegas.

The lower prices of converted condos are a big draw for would-be home buyers. Converted condos in Las Vegas cost $90,000 to $150,000. The median price of a new single-family home there is $305,500.

Converted condos are attractive to empty-nesters who want to downsize, but they are most popular with first-time home buyers, particularly firefighters, teachers and others who earn moderate incomes in expensive markets, says Walter Molony, spokesman for the Chicago-based National Association of Realtors.

Some cities where condo conversions are underway have the nation's lowest apartment vacancy rates, triggering concerns among local officials that renters are being left with few places to go.

In the Washington area, the vacancy rate for multifamily rental units was 3.6% as of July 1, according to the Realtors group. The rate was 2.9% in Miami and 2.7% in San Diego. The projected national average vacancy rate this year is 5.7%.

"We are definitely concerned about the displacement (of tenants) and the loss of rental housing, particularly affordable rental housing," says Melodie Baron, division chief for the Office of Housing in Alexandria, Va. Since November, applications have been filed to convert 2,365 rental units in that city.

Here's what some cities are doing to ease the crunch:

• Alexandria is offering interest-free loans of as much as $40,000 to tenants with moderate incomes who want to buy their unit when it goes condo.

• Clark County in Nevada is allowing homeowners on lots of 5,000 square feet or more to build another structure that they could rent to people who are not family members.

• The San Diego City Council has set aside $1.9 million for loans to displaced renters who earn the area's median income of $64,000 a year or less. Displaced tenants receive three months' rent, which they can use for a down payment on a home or another rental.

DeForest was worried when he learned five months ago that his bungalow community was going condo.

"It was a little scary because everything is just sky-high here ... and I don't make a whole lot of money," he says. But he also saw a chance to become a homeowner.

Fiel Barrow, 29, who attends San Diego State University, paid $217,000 in April for a converted one-bedroom condo. He says he was able to buy only because of the relatively low cost of the condo and loans he obtained through programs for first-time home buyers.

Mayor Mark Lewis of El Cajon, a San Diego suburb where apartments make up 52% of housing, welcomes conversions. Conversions enable residents to put down roots, and they also increase tax revenue for city services, he says.

Art Madrid, mayor of neighboring La Mesa, isn't so sure conversions help his town. La Mesa ties the number of conversions it will allow to the number of apartments built in the previous two years. No apartments have been constructed in the past decade.

"I think we have a legal and moral responsibility to make sure that the residents who've lived here for years and years aren't displaced just for the sake of money," Madrid says.

[MORE]

NEWS: Mortgage Bankers: Desperate to Lend

2005-06-27T05:08:00.000-07:00

BUSINESS WEEK
JUNE 27, 2005

By Peter Coy

Refinancing volume has tumbled, as has profitability, so these lenders offer increasingly sweet deals in a scramble for market share

One of the more puzzling aspects of the current housing boom is that mortgage lenders have been offering ever-sweeter deals on loans. These days it's increasingly easy to qualify for a loan with little or no money down.

The market is rife with interest-only loans, as well as "option ARMs" that allow borrowers to roll part of the interest they owe back into the principal on the mortgage (see BW Online, 6/16/05, "The Mortgage Trap"). It has gotten so bad that you hear anecdotes of some lenders not even requiring proof of income before handing over a million bucks to a homebuyer.

PROFITABILITY SLUMP. Why have lenders been so liberal when they run the risk that many of their marginal customers will go into default? The answer is surprising. Sure, long-term interest rates have at times continued to defy conventional wisdom and decline or hold steady while the Fed hiked short-term rates. This gives lenders a lot of room to keep their rates to customers as low as possible.

But it turns out that's just part of the reason lenders are offering such unbelievable deals to their customers. Many lenders are just plain desperate for business, according to some experts. In a bid for market share, mortgage lenders are offering highly favorable terms to borrowers. That's forcing the rest of the industry to match their terms or lose customers.

The industry's underlying problem is simple: Overcapacity and a drop in profitability from its all-time high of 2003. And that's not the claim of an industry gadfly. It's the analysis of the sector's own top economist, Douglas Duncan, the chief economist of the Mortgage Bankers Assn. Duncan told BusinessWeek on June 23 that profits fell by 70% from 2003 to 2004 among 70 lenders that supply their internal data to the trade group.

GREAT FOR BUILDERS. The Mortgage Bankers Assn.'s profit numbers are not available from any other source because most of the lenders are privately held and are not required to reveal their P&L's to the public. Several of the biggest lenders are publicly held and have performed better than the industry composite.

Many experts credit the availability of cheap loans to a wide swath of the public as one of the factors behind the enormous run-up in housing prices, especially in coastal states. In the U.S., homes' appraised value made up 145% of nominal gross domestic product in March, while stocks and mutual funds were worth 82% of GDP, according to the Federal Reserve.

That's great for homebuilders, who are reporting some of the best profits in years (see BW Online, 6/22/05, "Builders Keep the Home Runs Coming"). But earnings for lenders have fallen off because there's less refinancing than in the peak year of 2003.

OVERCAPACITY CONCERN. Yet in spite of the profit pressures, Duncan told BusinessWeek that he believes lenders on the whole are behaving responsibly. One reason: If lenders resell a mortgage into the secondary market and then the borrower defaults, they can sometimes be forced to buy the loan back, eating the loss. He says he's not worried that the industry is setting itself up for a wave of defaults.

Analyst Paul Miller of the brokerage firm of Friedman Billings Ramsey agrees, saying the big lenders are being prudent and refusing to make loans that would violate their own standards for minimum projected profitability.

Nonetheless, the numbers that Duncan cites show why overcapacity is a concern. The lending business simply doesn't have enough customers to support its current size. In 2003, the industry originated about $3.9 trillion worth of loans, Duncan says. Last year, that figure dropped to some $2.6 trillion because interest rates rose, so although the new home market was hot, fewer people applied to refinance existing mortgages.

That left lenders with "lots of excess capacity," he told BusinessWeek. While lending might go up slightly in 2005, he says, it still won't be anywhere near the 2003 peak.

BILL WITH POOR PROSPECTS. Says analyst Miller: "The industry keeps coming up with cheaper and cheaper products to keep the pipeline full." Even after layoffs, "there are companies that are still too fat," he says. He predicts that some smaller firms will go bust if lending shrinks this year or next.

Congress is considering a proposal that would give the federal government authority over lending practices. Currently the practices are governed by a patchwork of state regulations. The bill before Congress was introduced partly because of worries about foreclosure rates and whether lenders are ensuring that borrowers have adequate resources to repay loans. Most experts don't give the bill much chance of passing.

Still, the next time someone dangles an incredible loan offer in front of your face, you'll have a better idea why.

[MORE]

NEWS: Higher Odds Of Regional Housing Busts

2005-06-20T05:23:00.000-07:00

By RUTH SIMON and JAMES R. HAGERTY

Staff Reporters of THE WALL STREET JOURNAL

June 20, 2005; Page A8

A report by Fannie Mae says the probability of housing busts has "risen sharply in certain parts of the country," partly because of looser lending standards.

The report, presented to a group of home builders in Washington last month but not yet released publicly, finds conditions in many parts of the country "mirror past conditions that preceded regional housing busts." Among other things, it cites increases in the number of riskier loans, including ones that allow buyers to delay repaying the principal or that aren't backed by full documentation of the borrower's income and assets.

The report adds, however, that it is impossible to know whether there is a housing "bubble" until after the fact.

The analysis is notable because Fannie and the smaller Freddie Mac are the nation's biggest purchasers of mortgage loans. The two government-sponsored companies buy loans from lenders and package them into securities for sale to investors. They have long played a big role in setting standards for home loans.

Their ability to set standards, however, is eroding rapidly as they lose market share to private-sector rivals. Fannie and Freddie helped finance about 43% of new home mortgages in 2004, down from 59% a year earlier, according to Inside Mortgage Finance, an industry publication. Lenders increasingly are selling loans to rivals with more flexible credit standards. Fannie's capacity to buy loans also has been hampered by its need to shore up capital in the wake of an accounting scandal.

The Fannie analysis shows a loosening of standards for loans included in "private-label" mortgage securities, those that aren't backed by Fannie, Freddie or Ginnie Mae, a government agency that guarantees payments on federally insured loans.

The shifts are particularly notable for home-purchase loans to people with blemished credit records. Nearly 24% of the total value of "subprime" loans included in private label securities last year were adjustable-rate mortgages with an interest-only payment feature. On such loans, borrowers don't need to pay down the principal in the early years. Interest-only mortgages are considered riskier because borrowers don't build up any equity during the interest-only period and face sharply higher payments once they have to start paying back the principal.

Debt loads also are climbing. Mortgage borrowings rose to an average of 91% of the home value last year, from 85% in 2001. If home prices fall, high debt levels make it more likely a house will be worth less than the mortgage balance.

The report found similar shifts among home buyers taking out mortgages larger than the maximum size purchased by Fannie and Freddie, currently $359,650. For instance, the share of "jumbo" mortgages issued with full documentation of the borrowers' income and assets fell to 49% last year from 73% in 2001.

Of course, Fannie could hope to gain by questioning rivals' practices. Asked about that, a spokeswoman said "a chorus" of voices is raising concerns about "the layering of risks." What is more, Fannie and Freddie do buy interest-only loans and mortgages without full documentation.

The report says lending patterns of the past year are similar in some ways to those of the late 1980s, shortly before prices fell in parts of the U.S., including Southern California and New England.

Table: Easier Money
Percentage of subprime home-purchase laons with interest only payments
2001 0%
2002 1.8%
2003 8.2%
2004 23.5%

Percentage of fully documented income and assets for home purchase loans

2001 70.4%
2002 60.9%
2003 57.6%
2004 55.1%

Note: Data are for home purchase loans in mortgage securities not guaranteed by Fannie Mae, Fredie Mac, or Ginnie Mae.

Sources: Fannie Mae, UBS, LoanPerformance

NEWS: Booming Local Housing Market

2005-06-20T05:14:00.000-07:00

Weigh Heavily on Overall Sector

By GREG IP

Staff Reporter of THE WALL STREET JOURNAL

June 20, 2005; Page A1

New federal housing data show that the nation's most overheated local housing markets now make up such a large share of the total U.S. market that a sharp fall in their values could stall or slow national economic growth.

The 22 major metropolitan markets with the fastest-growing house prices account for 35% of the value of the nation's residential real estate, but just a fifth of its population, says the Federal Deposit Insurance Corp.

Their share of the national real-estate market has risen quickly. In 2000, the 22 markets accounted for 27% of all U.S. residential real estate. In 1995, the figure was just 24%.

Some economists say local bubbles are less worrisome than a nationwide one because they are more likely to pop individually, in response to local events, reducing the national fallout. And Federal Reserve Chairman Alan Greenspan recently has said that the U.S. has no national housing bubble, but there are "signs of froth in some local markets."

But the latest data suggest that real-estate values in the nation's fastest-growing markets are getting so large that the distinction between them and the national market could become meaningless.

"It's a widespread boom and has macro implications," says Richard Brown, chief economist of the FDIC. "A slowdown would not only hurt these markets, but the U.S. as a whole." (See related article1.)

Says Mark Zandi, chief economist at Economy.com, a consulting firm specializing in regional economic analysis, "If you tote up the metropolitan areas that are bubble-like, it's closing in on half the housing stock. Another year of these price gains and I think it would qualify as a national house price bubble even though not every corner of the country is experiencing speculative activity."

The FDIC considers a local market to be a boom market if it has appreciated 30% or more, adjusted for inflation, in the past three years. It says 55 of the country's 362 local metropolitan markets qualified in 2004. Together, they accounted for roughly 40% of all the value of residential real estate in the country -- up from about 30% in 2000.

The agency has detailed data for only 22 of those 55, though they include most of the largest and among the priciest of those 55 markets. The two largest metropolitan areas, New York and Los Angeles, each have a value of more than $1 trillion. Adding in the Boston, Washington, D.C., and San Diego metropolitan areas, the top five boom markets are valued at $4 trillion, or 24% of the national total, while those markets represent just 12% of the U.S. population of 294 million.

FDIC economists prepared the local estimates at the request of The Wall Street Journal. The FDIC is an independent federal agency that provides insurance for most bank deposits and regulates state-chartered banks that aren't members of the Federal Reserve system.

The disproportionate concentration of housing wealth in a few markets is reminiscent of how a few technology and blue-chip companies drove the bull and bear markets in stocks starting in the late 1990s.

The Standard & Poor's 500-stock index rose 45% from the end of 1997 to February 2000, but the average stock rose just 14%. Over the next three years, as technology companies plummeted, the index fell 36%, but the average stock fell just 2%, according to Aronson+Johnson+Ortiz, a Philadelphia money manager.

At the same time, houses are unlikely to fall anywhere near as sharply as stocks can. That's because it's costly for families to move, and sellers are more likely to take a house off the market if they can't get an acceptable price.

If the 55 boom markets declined 15% while the rest of the country was flat, national housing prices would drop 6% -- on a par, adjusted for inflation, with previous national housing pullbacks, but hardly a crash.

Unlike stocks, the housing market "would be more likely flat with 10% to 20% declines in some regions, or down slightly nationally with some regions looking ugly," says Ethan Harris, chief U.S. economist at Lehman Brothers. Even local housing crashes take years to unfold, he says.

Still, a flat housing market could damp overall economic growth by restraining new construction and consumer spending financed by borrowing against home values. Mr. Harris estimates that if the overheated local markets declined 10% a year for three years, while the rest of the country rose 5% a year, it would reduce U.S. economic growth from 4% to about 2.5%.

Federal Reserve officials expect housing prices eventually to level off and restrain consumer spending. But they believe business investment and exports will increase by then and pick up the slack, maintaining overall growth for the U.S. economy.

Though the U.S. hasn't experienced a serious, nationwide decline in home prices in the past three decades, many local markets have fallen sharply. Prices rose sharply in Southern California in the late 1980s, then collapsed in the early 1990s as the economy reeled from a national recession and deep cuts to defense spending.

"Our economy, especially in Los Angeles County, was devastated," says Michael Bazdarich, senior economist at UCLA Anderson Forecast, an economic research center at the University of California at Los Angeles. The defense cuts alone would have caused a serious local recession, he says. But those cuts along with a reversal in home prices "combined to wreak havoc on the local economy." The damage was amplified by mortgage defaults that brought down the region's largest savings and loan institutions.

Mortgage defaults remain low, but a reversal in home prices could change that. Goldman Sachs mortgage analysts say a delinquent borrower in a rising market can use the equity in his home to qualify for a new loan, but loses that option when prices stagnate or decline.

Goldman Sachs studied the experience of Southern California's Orange County, where subprime mortgages -- those issued to less-creditworthy borrowers -- issued in 1992 defaulted at far above the national average, while subprime mortgages issued in 1999, during the current boom, defaulted far less. They estimate that in a region with strong price appreciation now and a subprime default rate of about 1%, several years of declining prices could push defaults to 8% to 10%.

But analysts say even overheated local markets are unlikely to suffer as much as Southern California did a decade ago. The FDIC's Mr. Brown defines a housing bust as a decline of 15% or more, unadjusted for inflation, over five years. For that to happen, he says, "historically, you need severe local economic conditions." The markets where house prices are appreciating the most "are pretty well diversified economies" that don't depend heavily on a single industry like defense or energy, he says.

However, the FDIC cautions that in the past year, national factors such as low mortgage rates and easier lending standards are displacing local factors in driving home prices, so previous experience may be less useful.

Mr. Zandi of Economy.com adds that local housing collapses in New England and Southern California in the late 1980s and early 1990s "infected the broader banking system." Banks today are better capitalized, and thanks to consolidation, less exposed to any single region, he says. Moreover, banks have "securitized" many of their mortgages -- that is, repackaged them as standalone securities and sold them to investors and to federally chartered companies Fannie Mae and Freddie Mac.

But for the same reason, he warns, "No one really has a grip on who has the risk." If something goes wrong in the mortgage market, a lack of transparency could cause investors to shun good and bad borrowers alike, he says.

The low long-term interest rates of recent years are a key factor tying all local bubbles together in the U.S., says Edward Leamer, chief economist at the UCLA Anderson Forecast. If those rates rise sharply, they will "kill off those bubbles all at the same time."

David Lereah, chief economist at the National Association of Realtors, says a local market becomes most vulnerable to collapse when it experiences rapid price appreciation, rising inventories of unsold homes and a high concentration of lending on loose terms, such as interest-only mortgages.

At present, he says, no market is experiencing a "meaningful" rise in inventories -- in fact, the hottest markets tend to have less inventory than average. He says those markets also tend to have the most limited supply of new housing because of land shortages or regulatory constraints.

Booming northeast and California housing markets dominate national real-estate value

Area (Bolding indicates boom market)	Estimated Value (in billions)	Share of U.S. Market*	Share of U.S. Population
Los Angeles-Long Beach CA PMSA	$1,171.4	6.8%	3.4%
New York NY PMSA	1,145.7	6.6%	3.2%
Boston MA-NH PMSA	720.9	4.2%	2.1%
Chicago IL PMSA	631.9	3.7%	2.9%
Washington DC-MD-VA-WV PMSA	562.4	3.3%	1.8%
Orange County CA PMSA	497.8	2.9%	1.0%
San Diego CA MSA	469.8	2.7%	1.0%
San Francisco CA PMSA	350.1	2.0%	0.6%
Nassau-Suffolk NY PMSA	323.1	1.9%	1.0%
Riverside-San Bernardino CA PMSA	311.4	1.8%	1.3%
Philadelphia PA-NJ PMSA	299.2	1.7%	1.8%
Seattle-Bellevue-Everett WA PMSA	242.5	1.4%	0.9%
Newark NJ PMSA	224.1	1.3%	0.7%
Atlanta GA MSA	214.2	1.2%	1.5%
Minneapolis-St. Paul MN-WI MSA	206.4	1.2%	1.1%
Baltimore MD PMSA	202.5	1.2%	0.9%
Phoenix-Mesa AZ MSA	196.9	1.1%	1.2%
Miami FL PMSA	194.8	1.1%	0.8%
Houston TX PMSA	182.1	1.1%	1.6%
Sacramento CA PMSA	179.3	1.0%	0.6%
Fort Lauderdale FL PMSA	172.8	1.0%	0.6%
Denver CO PMSA	171.2	1.0%	0.8%
Dallas TX PMSA	161.3	0.9%	1.3%
Las Vegas NV-AZ MSA	157.1	0.9%	0.6%
Tampa-St. Petersburg-Clearwater FL MSA	153.5	0.9%	0.9%
Portland - Vancouver OR-WA PMSA	137.4	0.8%	0.7%
New Haven-Bridgeport-Stamford-Danbury-Waterbury CT NECMA	135.1	0.8%	0.6%
St. Louis MO-IL MSA	109.2	0.6%	0.9%
Orlando FL MSA	101.7	0.6%	0.6%
Kansas City MO-KS MSA	90.2	0.5%	0.6%
Pittsburgh PA PMSA	89.1	0.5%	0.8%
Cincinnati OH-KY-IN PMSA	78.7	0.5%	0.6%
Indianapolis IN MSA	67.1	0.4%	0.6%
San Antonio TX MSA	61.4	0.4%	0.6%
Total for Largest Markets	$10,012.4	58.1%	39.5%

PMSA = Primary Metropolitan Statistical Area
MSA = Metropolitan Statistical Area

*Based on median values and number of units method

Source: Federal Deposit Insurance Corp.

REPORT: State of the Nation's Housing 2005

2005-06-17T18:41:00.000-07:00

Joint Center for Housing Studies

(Cambridge, MA) In 2004, housing markets posted record growth. Homeownership reached an all time high of 69 percent, with households of all ages, incomes, races and ethnicities joining the home buying boom. Single-family starts hit a record 1.6 million units, while new and existing home sales grew to nearly 8 million. Mortgage product innovations helped markets stay hot. Subprime loans gave millions with blemished credit records, who would previously have been denied a loan, the chance to buy a home. Meanwhile, interest-only and adjustable rate loans are helping blunt the impact of higher home prices. Indeed, adjustable rate mortgages accounted for more than a third of all mortgage loans last year and interest-only loans for nearly one-quarter. “The irony of today’s housing market is that while fundamentals are supporting record levels in residential investments, housing affordability problems are climbing the income

[MORE]

NEWS: The Mortgage Next Door

2005-06-17T07:12:00.000-07:00

Business Week:

You've hunted for a new house for months, and now you're ready to bid. But before you do, check one more indicator to see whether you're making a smart purchase: the types of mortgages home buyers in your market are choosing.

If lots of your prospective neighbors are taking out loans with low initial payments but much higher costs down the road, it could mean that they're stretching to buy houses they otherwise couldn't afford. That's a sign of an overpriced market.

The red lights are flashing in San Diego, Atlanta, San Francisco, Denver, and Oakland. Last year, they had the highest share of single-family-home mortgage loans that require just interest payments -- no principal -- in the early years. San Diego led overall with 47.6% of home buyers taking out interest only mortgages, up from 1.9% as recently as 2001.

Providence, Indianapolis, Houston, Pittsburgh, and Milwaukee are at the other extreme, with fewer than 8% of buyers going for interest-only mortgages last year. The data, which appeared first on BusinessWeek Online, were supplied by LoanPerformance, a San Francisco real estate information service. On a national basis, the LoanPerformance numbers closely track those of Fannie Mae Corp. and Freddie Mac Corp., even though those companies buy standard mortgages while LoanPerformance's numbers cover only big-ticket "jumbo" loans and subprime mortgages.

Why are interest-only mortgages a warning sign of a possible bubble? They tend to be most popular in overheated markets, where buyers are looking for every trick to make their monthly payments affordable. Initial payments on an interest-only mortgage are low because borrowers aren't required to pay any principal. But after a period of time -- from 2 to 10 years -- principal payments begin, and the monthly payment jumps by as much as 50%.

Be especially cautious of markets in which option adjustable-rate mortgages are hot. These loans offer borrowers extremely low teaser rates -- typically, just 1% for the first month -- and allow the option of making a minimum payment that may not even cover all of the interest owed for the month. The unpaid interest gets added to the principal, so the total owed can swell like a credit-card bill. Borrowers may be enticed by the introductory rate but unprepared for later payments on the swollen principal. Keith M. Schemm, a mortgage broker in Santa Clara, Calif., says option ARMs are "pretty dangerous loans to do" for many families. "The problem is there's such a frenzy in the marketplace to buy a home."

In assessing a market, also look at whether house prices are high relative to local incomes and relative to rental rates on equivalent properties, and at the health of the local economy. If major employers have recently closed, home prices are likely to head down. But if you're worried about buying at the top of the market, knowing what kind of mortgages your neighbors are choosing should help you make a more informed decision.

By Peter Coy in New York

NEWS: The Mortgage Trap

2005-06-17T07:10:00.000-07:00

Business Week:
Lenders are cranking out an ever-growing array of financing schemes and lowering standards to keep the boom going.

Nicki Randolph, a San Francisco real estate agent, hasn't been scared off by talk of a housing bubble. Although she already owns both a home and a condo in Palm Springs, Calif., Randolph just closed on a third property -- dropping more than $1 million on a 1,400-square-foot loft in the heart of San Francisco. How does she juggle so many properties in the overheated California market? Lots of leverage, thanks to banks all too willing to provide ever more. To finance her loft purchase, Randolph took out a mortgage that lets her pay only interest for the first five years -- a tactic that helps her ease into the hefty monthly payments. "Fears that the market is going to crash are way overstated," she says confidently. "It's a seven-mile-by-seven-mile city and a premier place people want to live. You have to be more aggressive here because the prices are so high."

PRESSURE KEEPS BUILDING
Randolph's story is a familiar one -- and it shows the lengths to which buyers are willing to go to snatch up real estate as well as the extremes lenders will stretch to accommodate them. As prices continue to skyrocket in much of the country, banks and lenders are cranking out an ever-growing array of products ranging from no-money-down or interest-only mortgages, to special "Payment Power" loans that allow homeowners to defer monthly payments altogether twice a year. Such creative financing is letting even marginal buyers purchase houses with price tags that used to appeal only to the rich and famous. In the process, banks and mortgage companies appear to be taking on more risk than ever before -- and if rates rise sharply or prices tumble, many of their customers could find themselves in deep trouble, too.

All those innovative mortgage products are a sure sign that lenders are doing everything they can to keep the housing boom going and to capitalize on yet another round of falling interest rates that no one expected. There are plenty of other signs of frenzy as well. Home appraisers complain that mortgage originators are demanding the optimistic appraisals needed to close on loans. "They started warning me to 'be a team player' and to 'hit the number' they needed to seal the deal," says Robert Burnitt, an appraiser in Midlothian, Tex. Enticed by juicy commissions from all those deals, others are jumping into the mortgage biz. Among them are John Switzer, an 18-year-old high school grad from New Bern, N.C., who put off college so he could start work as a mortgage rep for Houston-based Franklin Bank Corp. (FBTX ) "Right now, mortgages are a little more interesting" than college studies, he says.

Yet nothing screams "frenzy" louder than the huge popularity of innovative -- and risky -- mortgage products that allow buyers to stretch for those million-dollar studios and multimillion-dollar suburban colonials. With interest-only mortgages now offered by everyone from ditech.com to Washington Mutual Inc., such loans now account for 20% of all new mortgages, up from under 5% two years ago. Option adjustable-rate mortgages, or "option ARMs," have also become all the rage in superheated markets such as California and Washington, D.C. With an option ARM, borrowers can choose among three different payment plans each month, continually changing what they fork over as their budgets shift. The options: a regular payment of both principal and interest, just the interest, or one that may not even cover the interest -- so the overall balance owed on the mortgage could continue to grow.

The question is, will the proliferation of interest-only and option ARM mortgages leave many buyers strapped down the road, causing higher default rates? David Liu, a mortgage strategist for UBS (UBS ) in New York, notes that after similar products were introduced in the red-hot California market in the late 1980s, they ultimately incurred a default rate that was three times as high as conventional mortgages when the local economy went into recession in the early '90s. Already there are signs that current option ARM borrowers are straining to make their monthly payment: Liu notes that among a bundle of mortgages originated by Washington Mutual and securitized into the secondary market last year, fully 60% of borrowers made only the minimum payment this past March. "That's definitely a sign that people are stretching,"says Liu.

There's plenty of other evidence suggesting that homebuyers and their lenders are climbing out on a limb. According to a survey of homebuyers released last November by the National Association of Realtors, 25% of those polled were able to get a mortgage with no money down, vs. 18% in early 2003 and virtually none in the late 1990s -- a trend that could leave many of these new homeowners under water if home prices take even a small dip. At the same time, lenders are extending far more loans to borrowers who have had credit problems in the past. According to the Mortgage Bankers Assn., the share of new loans made to so-called subprime borrowers -- usually lower-income individuals with spotty credit histories -- rose to 28% in the second half of 2004, a sharp jump from the less than 5% of all lending that subprime represented back in 1994. "I think there are going to be some blowups," says Bert Ely, a bank consultant based in Alexandria, Va. "These are people who are most vulnerable to job loss."

If the housing market swoons and homeowners get into trouble, the mortgage industry won't be far behind, many critics worry. "I'm very nervous about the risk of higher foreclosures down the road," says Stuart A. Feldstein, president of SMR Research Corp., a mortgage research firm in Hackettstown, N.J. And on June 9, Federal Reserve Chairman Alan Greenspan revealed his unease when he warned Congress that "the apparent froth in housing markets may have spilled over into mortgage markets." He noted that the increasing use of interest-only and other "relatively exotic" mortgages are "of particular concern."

SAFEGUARDS
Lenders insist that worries about their standards are overblown. They maintain that, thanks to the advent of automated underwriting during the 1990s, their ability to analyze statistical trends in lending is far better than before, enabling them to better price loans according to risk. "Underwriting is still more of an art than a science, but we're making it far more of a science," says Joe Anderson, a senior managing director at Countrywide Financial Corp. (CFC ), a Calabasas (Calif.) mortgage lender. And lenders note that they've instituted more safeguards since the last housing boom in the 1980s, such as requiring that borrowers have several months of liquid assets to assure that they can keep paying their mortgages in the event of a job loss. "On a scale of 1 to 10 -- with 10 being the worst-case scenario -- my concern level is only around a 2 right now," says D.C. Aiken, senior vice-president for pricing and products at HomeBanc Mortgage Corp. (HMB ), a large lender in Atlanta.

Still, regulators are redoubling their efforts to make sure the banks are right. The Federal Reserve and other bank regulators recently ordered lenders making home-equity loans and lines of credit to do a more in-depth analysis of borrowers' income and debt levels and their ability to repay loans -- instead of relying heavily on credit scores, as many lenders have been doing. And regulators say they're busily drafting similar guidelines for mortgage lending as well. State regulators are also starting to rein in hyper-aggressive lenders. In Illinois, legislators passed a bill that would give a state agency the power to review mortgage applications in lower-income areas to determine whether borrowers should be required to attend loan counseling -- paid for by the loan originator -- before receiving the loan. That, lawmakers figure, will discourage brokers from extending loans to high-risk borrowers who have a high probability of ending up in foreclosure.

Of course, Nicki Randolph and many more like her who have used lenders' aggressive mortgage offers to expand their fledgling real estate empires aren't normally thought of as high-risk borrowers. But if interest rates and housing prices don't follow the rosy script that Randolph and so many others are banking on, a whole lot of homeowners could be caught in a painful trap.

By Dean Foust, with Peter Coy in New York, Sarah Lacy in San Mateo, Rishi Chhatwal in Atlanta, and bureau reports

NEWS: Rise Across the Global Village

2005-06-17T07:08:00.000-07:00

The Infinity highlights a remarkable turnaround for a city whose property market went belly up in 1997, and it points to an important facet of this housing boom: It's global and, in some places, more dramatic than in even the most frenzied U.S. markets.

Armed With a 'Saving Glut,'
Investors Chase Returns;
Londoners Buy in Bulgaria

Bangkok Market Is Hot -- Again

By JON E. HILSENRATH and PATRICK BARTA
Staff Reporters of THE WALL STREET JOURNAL
June 16, 2005; Page A1

It was a familiar story from Golden Land Property Development PLC. With its 35-story Sky Villas condominiums nearly sold out, it unveiled plans for an even more lavish project. The Infinity features a replica of Rome's Spanish Steps, a spa in a restored historic mansion and faux-Venetian canals. About 90% of the units in the new development sold out in less than three months, even though some were priced at more than $1 million.

The project isn't in a hot U.S. real-estate market like Las Vegas or Miami. It's in Bangkok, where home prices are soaring, bank mortgage lending is climbing and developers are adding thousands of glitzy units.

Over the past three years, measures of housing values are up 48% in France, 63% in Spain and they've nearly doubled in South Africa, according to data gathered from these markets from sources including the Bank for International Settlements, Economy.com and The Wall Street Journal. In just the past year, prices have risen 19% in Hong Kong and 48% in Bulgaria. They've also boomed in China, Australia and the United Kingdom, though prices are now showing signs of slowing in some markets like Australia and the U.K.

Americans are searching out castles in Umbria. Londoners are gobbling up beachfront property on the shores of Bulgaria. Europeans are finding dream homes on the Indian Ocean near Durban. And in Bangkok, eight years after the city's property market collapsed, Golden Land is seeking buyers from Thailand and abroad with a sales pitch that promises "an environment so opulent, only in your dreams could it be imagined."

"There is a tremendous amount of money floating around looking to invest," says Liakat S. Dhanji, the Nairobi-born chief executive of Golden Land.

Low interest rates -- increasingly moving in sync around the world -- are the clearest engine of this global boom. But there are many other factors tied into the trend, including the increasingly unconstrained flow of capital around the world, aggressive lending by banks here and abroad and a frantic search by investors, large and small, for returns that beat stocks and bonds.

STICKER SHOCK

Home-price appreciation for 27 countries over the past year and three years.

Rank	Country	One-Year Change	Three-Year Change
1	SOUTH AFRICA *	28%	95%
2	CHINA (Shanghai)*	27%	68%
3	SPAIN *	17%	63%
4	AUSTRALIA *	-3%	56%
5	NEW ZEALAND ^	16%	55%
6	UNITED KINGDOM *	11%	50%
7	FRANCE *	15%	48%
7	IRELAND ^	13%	42%
9	CANADA *	10%	31%
10	UNITED STATES *	11%	29%
11	THAILAND *	13%	29%
12	SWEDEN *	10%	27%
13	HONG KONG *	19%	27%
14	HUNGARY(Budapest)*	5%	27%
15	FINLAND *	6%	23%
16	EURO AREA *	7%	22%
17	GREECE (Ex-Athens) *	4%	22%
18	KOREA *	-2%	20%
19	NORWAY *	10%	17%
20	DENMARK ^	9%	17%
21	TAIWAN *	10%	15%
22	NETHERLANDS *	5%	11%
23	SWITZERLAND *	1%	8%
24	PORTUGAL *	0%	3%
25	GERMANY *	-3%	-5%
25	JAPAN *	-5%	-16%
26	BULGARIA *	48%	NA
27	INDONESIA ^	5%	NA

*Based on latest available statistics updated through fourth quarter 2004 or first quarter 2005.
^Based on statistics updated between second quarter and third quarter of 2004. Percent changes are calculated using city or national indexes of residential property prices, home prices, existing home prices or prices per square foot.

Sources: Bank for International Settlements, Economy.com, CEIC, and Wall Street Journal Research.

The global nature of the boom defies conventional thinking on housing. Economists traditionally say real estate, which can't easily be traded like a stock or oil, is driven by local factors -- like the availability of land in an area or regional employment trends.

"The housing market in the United States is quite heterogeneous, and it does not have the capacity to move excesses easily from one area to another," Federal Reserve Chairman Alan Greenspan told Congress last week. "Instead, we have a collection of only loosely connected local markets."

International Monetary Fund research suggests house-price gains are squeezing affordability in places like Spain, Ireland and the U.K. So far, though, the surging real-estate prices have been concentrated mostly in areas that hold appeal for global investors: large cities tied in to global finance and attractive vacation and retirement destinations.

Most economists still believe a housing slowdown, if it actually comes, would be absorbed by the global economy without much disruption to overall growth rates. Indeed, it is possible the globalization of this boom helps to spread out the risk associated with it.

But if home prices were to fall broadly, it could stress the global financial system, since banks and investors world-wide have been gobbling up mortgages and real estate at increasing rates. It could also undermine the ability of individuals to spend, since so much wealth is now tied up in homes.

While local factors do play a critical role in shaping real-estate values -- prices have risen more in Miami than Memphis and they've fallen in Germany and Japan -- some economists are beginning to concede that global factors can play just as important a role. Researchers first recognized the global pattern in commercial real-estate markets after the office booms and busts that marked the 1970s and 1980s. Now they're seeing it in residential housing, too.

In a study written last year, IMF economist Marco Terrones found 40% of house-price movements around the world were driven by "global factors" that translate across borders, like interest rates and economic growth. "Just as the upswing in house prices has been mostly a global phenomenon," Mr. Terrones argued, "it is likely that any downturn would also be highly synchronized, with corresponding implications for global economic activity."

Prices are already showing signs of slowing or even falling in some places. In Australia, for instance, measures of median home prices rose about 60% during 2002 and 2003, but have fallen slightly in the past year while other measures of home prices have gone flat. In the U.K., the Netherlands and Korea, they also have lost some momentum. In many other parts of the world, regulators are working hard to cool housing fever. Real-estate brokers in China, for instance, have seen signs of a sales slowdown since Chinese authorities imposed a 5.5% tax on properties that are sold within two years of purchase.

"I'm worried about a world recession when this thing finally unravels," says Robert Shiller, a Yale University professor and author of the book "Irrational Exuberance."

Mr. Shiller's own university is an example of how globalization touches a uniquely local asset like real estate. Managers of Yale's $13 billion endowment are increasingly looking outside the U.S. and outside of traditional stock and bond investments to diversify the school's portfolio.

In November, Dean Takahashi, senior director in Yale's investment office, rang the opening bell on the stock exchange in Bucharest. Then he told local reporters the university would be increasing its $20 million of investments in Romania, including some real-estate projects. "We see enormous potential" for foreign investment in residential real-estate projects, says Siminel Andrei, head of NCH Advisors Inc., the administrator of the Romanian unit of New Century Holdings, which manages some investments for Yale outside the U.S.

It is not just the free flow of capital that has globalized the boom. It's also the free flow of people. Doug Platt, a 41-year-old New York executive, counts on outsiders to flock to Italy. He and a group of family and business associates are negotiating for the purchase of a 12th-century castle in Umbria for just over $5 million. Mr. Platt and his partners plan to carve the castle into 20 units and sell them to Londoners looking to hop over to Italy on discount airlines. He says he'll keep one of the units for himself, because he and his Italian wife travel to the region frequently.

"If you are investing in Italy right now, one thing you will hear a lot is that the Italian economy stinks," he says. "But it doesn't really matter to us what is happening in the Italian economy. It's much more important to us what is happening 1,000 miles away in Britain."

While individuals and institutional investors spread bets on real estate, banks are directing more credit to home buyers. In the 12 nations that use the euro, mortgage lending has increased at an 8% annual rate since the end of 2000, according to Bank for International Settlements data. That's faster than the 5% rate of increase for corporate loans. Mortgage lending has grown at an 11% rate in the U.S. and a 6% rate in Japan, while business lending has contracted in both countries. In the U.K., mortgage lending was up at a 20% rate while business lending was up at an 8% rate.

Some reports suggest banks also have become willing to take more chances lending. An April survey of loan officers by the European Central Bank, for instance, found European banks eased lending standards for housing loans during the past four quarters. Citing increased competition from other banks, they reduced margins on mortgages and slightly eased "loan to value" ratio requirements. Surveys of loan officers in places like Poland and Hungary turn up similar results.

"Lenders and investors have to be careful that they exercise proper risk management. If they don't they're going to get burned," says William Rhodes, senior vice chairman of Citigroup. Mr. Rhodes says banks are better managed and better capitalized today than they were in the 1980s and 1990s, when he was helping to navigate debt crises in developing countries. But he's still becoming concerned about a housing bubble.

The disparity between mortgage lending and business lending points to an undercurrent beneath the housing boom. Roughly five years after the 1990s tech bubble burst, business investment is still relatively modest around the world. That contributes to what Ben Bernanke, a Fed governor who has been nominated to serve as chairman of the president's Council of Economic Advisers, calls a "global saving glut" -- a flood of financial assets looking elsewhere for a home. The phenomenon is helping to hold down interest rates and push up housing values.

Other factors contribute to the savings glut, including the growing reserves of Asian central banks. The boom in oil prices also has resulted in huge trade surpluses among oil-producing nations, many of which are recycling their newfound wealth back into the world economy by purchasing bonds and sometimes real estate. Moreover central banks have maintained relatively loose monetary policies in the wake of the 2001 recession and the uncertain recoveries that followed, adding liquidity to the financial system.

As a result, bond yields aren't just low in the U.S.: They are below 5% in Germany, France, Japan, the U.K. and Canada. That makes homes more affordable by reducing monthly mortgage payments. It also drives investors into real estate because the returns they can earn on bonds are so minuscule.

Equities have been a hair-raising alternative. The Dow Jones World Stock Index is down 1% so far this year, up 11% in the past 12 months and down 14% over the past five years.

"I see it on the face of people. They don't know what to do with the money," says Gary Garrabrant, who manages Equity International Properties Ltd., the international portfolio of Sam Zell, the real-estate investor who made his fortune scooping up distressed properties in the U.S. Mr. Garrabrant has been investing in homebuilders in Mexico and Brazil.

Bangkok Bank, Thailand's largest bank, is offering mortgages fixed for the first three years at a 5.25% rate, not much more than the rate on a five-year adjustable-rate mortgage in the U.S. The result: Mortgage lending in Thailand is up more than 20% annually, after contracting sharply in the late 1990s.

A property boom in Thailand would have seemed unthinkable a few years ago. Thai banks were reluctant to lend and the number of developers dropped to fewer than 100 from as many as 4,000 during the 1990s boom. Between 1997 and late 2002, there were no major condominium projects launched in Bangkok and government officials had to press the country's state-owned banks to extend more credit.

Now, there are some 14,000 condominiums in development in a city whose stock of existing units is less than 100,000. The number of single-family homes under construction shot up by nearly 80% over the past two years. Some analysts have started to worry that units in the city's most popular districts are being sold to speculators, who intend to resell them quickly for a profit. Average condo prices in Bangkok's high-end Sukhumvit expatriate district rose 34% in 2003, followed by an 18% gain in 2004.

Fearful of a 1990s repeat, Thailand's central bank has introduced rules that require banks to cap loans for large houses at 70% of the property's value and forced lenders to register major projects with the central bank. Regulators also began speaking publicly of a possible housing bubble. As a result, many analysts predict the country will avert another wrenching bust.

Golden Land Property nearly went belly up during the last downturn. It was rescued by Mr. Dhanji, a Canadian citizen who worked as a real-estate consultant in Hong Kong. Tapping into foreign investors like Morgan Stanley and financier George Soros, he says he raised $100 million and recapitalized the company.

Today, Golden Land has about 2,500 homes in the works or recently completed in Bangkok suburbs and more than 600 residential units planned or recently completed in the central business district. Its crown jewel is the downtown Infinity project. Condominiums will include Jacuzzi tubs with 270-degree views of the city. The company says it has raised prices 12 times since launching the project in mid-March due to high demand. Some 30% of the units are going to foreigners, many of whom see Thailand's luxury developments as a better value than pricy units in places like Shanghai, London or New York.

"There may be a [housing] bubble in the U.S. or Britain," says Gilbert N. Wong, an American executive whose company manufactures household appliances in Asia, but "there's no bubble here." He believes Bangkok is cheap relative to Tokyo or Hong Kong and he thinks incomes are rising so demand will grow. Mr. Wong is spending more than $2 million for two Golden Land units; one is for himself and the other he might use for his children.

Rising rates or a change in sentiment by global real-estate buyers are two main threats to the housing boom. In Bangkok, there aren't signs of serious problem for now. "I think the U.S. is at the top of the cycle," says Mr. Dhanji. But he says Asian real estate, which only began recovering in the past few years, "is just beginning."

---- Cristi Cretzan in Bucharest contributed to this article.

NEWS: The Trillion-Dollar Bet

2005-06-17T07:07:00.000-07:00

June 16, 2005

The Trillion-Dollar Bet

By DAVID LEONHARDT and MOTOKO RICH

American homeowners have made a trillion-dollar bet that mortgage rates will remain near record lows for at least a few more years. But with some interest rates already rising, economists worry that the bet could turn bad.

The problem is that new types of mortgages that hold down monthly payments for families - helping many buy homes that they would not otherwise be able to afford - also require potentially far higher payments in future years.

The bill will soon start to come due in a serious way, as the initial period of fixed payments, typically set at artificially low rates, expires for millions of homeowners with adjustable-rate mortgages.

This year, only about $80 billion, or 1 percent, of mortgage debt will switch to an adjustable rate based largely on prevailing interest rates, according to an analysis by Deutsche Bank in New York. Next year, some $300 billion of mortgage debt will be similarly adjusted.

But in 2007, the portion will soar, with $1 trillion of the nation's mortgage debt - or about 12 percent of it - switching to adjustable payments, according to the analysis.

The 2007 adjustments will almost certainly be the largest such turnover that has ever occurred.

The impact is not likely to derail the economy on its own, economists predict, but it will probably slow growth. For individual families, the problems could be significant.

"I'm not sure that people are being counseled on really how big of a risk they are taking," said Amy Crews Cutts, deputy chief economist at Freddie Mac, the mortgage company.

Consider a typical $300,000 interest-only mortgage with fixed payments for the first five years.

The homeowner would start by paying about $1,250 a month. If interest rates rise modestly over the next few years, as many forecasters expect, the payment will jump to almost $2,100 in 2010, according to Stephen Barrett, the owner of Redmond Financial, a mortgage business near Seattle.

With the help of new computer models, lenders have brought out newer and riskier mortgages to attract borrowers and increase their buying power during the long housing boom. The traditional 30-year mortgage with guaranteed payments is increasingly a loan of the past.

The hot loan of 2004 - the interest-only mortgage - allowed home buyers to pay no principal for the first few years of the loan, substantially lowering their initial payments.

It has remained popular this year, accounting for at least 40 percent of purchase loans over $360,000 in areas with fast-rising home prices, like San Diego, Washington, Seattle, Reno, Atlanta and much of Northern California, according to LoanPerformance, a mortgage data firm.

This year's fashionable model, known as an "option ARM," allows borrowers to make payments with monthly rates starting as low as 1.25 percent for the first five years of the loan; the average rate on a 30-year, fixed-rate loan is about 5.6 percent.

During the first quarter of 2005, 40 percent of mortgages over $360,000 issued to people with good credit were option ARM's, said David Liu, a mortgage strategy analyst with UBS in New York. Very few borrowers used option ARM's before 2003.

Many borrowers stand to benefit from these creative loans. On option ARM's, buyers with variable incomes, like the self-employed, can also make smaller or larger payments depending on their take-home pay in a particular month, without incurring penalties. With the average homeowner moving every six years, any loan with lower initial payments can substantially reduce housing costs.

"As a rule, I would prefer the 30-year fixed mortgage," said Alejandro Brown, 31, a technical trainer for Nissan, the automaker, who refinanced the mortgage on his 1,700-square-foot house in Auburn, Wash., with an adjustable-rate loan last year, reducing his monthly payments. But, he said, "I knew I wasn't going to be in my house more than three years; I was very confident."

All of these loans come with the risk of a spike in payments sometime in the future. In particular, borrowers who have taken out an interest-only loan will see a jump in payments simply because they will start to owe principal after the interest-only period lapses. If rates rise, the payments will go even higher.

Borrowers whose incomes have not risen enough or who have not planned for the higher payments could find themselves shocked.

"The apparent froth in housing markets may have spilled over into mortgage markets," Alan Greenspan, the Federal Reserve chairman, said while testifying to Congress last week. "The dramatic increase in the prevalence of interest-only loans, as well as the introduction of other relatively exotic forms of adjustable-rate mortgages, are developments of particular concern."

The lure of such loans is obvious. Because of the lower initial payments, buyers can purchase bigger and more expensive houses.

With her daughter leaving for college this summer, Linda Thompson decided to sell her four-bedroom house in the Seattle suburbs and move to a town house in the city's Lake Union neighborhood. But prices were so high that she had to go beyond her "level of comfort," she said, and spend $619,000.

She signed an interest-only mortgage that cut her monthly payments by about $500 compared with a conventional mortgage. Seven years from now, the bill will rise as she starts paying principal, and the size of the increase will be determined by interest rates at the time. But she may have moved by then, she said. And because the house is in an up-and-coming neighborhood, she expects the value to rise.

"The risk factor - of course it's always there," Ms. Thompson, 49, who runs a small marketing company, said as she was preparing to watch her daughter graduate from high school yesterday. "But to me, real estate is a better investment than the stock market."

"Just sitting there," she said of her new house, "it's appreciating right now."

Still, even some mortgage brokers are concerned by how much their clients are stretching their spending power using creative mortgages.

One possible warning sign is that a growing share of those taking out the aggressive loans is made up of lower-income families living in expensive areas, according to Economy.com, a research company. Another is that variable-rate mortgages have stayed popular even as long-term, fixed rates have gone down and rates on adjustable mortgages have risen.

"There are people who are buying homes that they shouldn't buy," said Eric Appelbaum, president of the Apple Mortgage Corporation in Manhattan. "People are saying, I can afford it on interest-only but I can't afford it" with a traditional mortgage, Mr. Appelbaum said. "It doesn't make any sense."

Since borrowers with interest-only mortgages are not yet paying down their debt, they are hoping to build up equity through an increase in home values. If house prices fall, as they did during the early 90's in some cities, borrowers will be forced to bring money to the table when they sell.

Even if home prices rise a little, borrowers who have taken out option ARM's and made only minimum payments for five years could find themselves in a hole. Such loans, which are typically based on rates that adjust monthly, give homeowners four payment options each month. In the first quarter of 2005, 70 percent of option ARM borrowers made the minimum payment, according to UBS.

In doing so, those borrowers effectively added more debt to the back of their loans.

On a $400,000 loan, for example, a buyer who made only minimum payments over the first five years would add more than $27,000 to the end of the loan, assuming short-term rates increase by one percentage point over the course of the loan, said Robert Binette, a mortgage broker with Hamilton Mortgage in Ridgefield, Conn. The monthly payment would jump from $1,718 in the final month of the fifth year to $2,580 after the loan was reset, a difference of more than 50 percent.

Borrowers who expect to cover the larger debt by refinancing could be in trouble if rates have increased. Thirty-year fixed-mortgage rates are near their lowest level in a generation.

Nationwide, the increase in monthly payments as more mortgage rates start to float will cost families about an extra $40 billion over the next two years, according to estimates by Credit Suisse First Boston. That is the rough equivalent of a 40-cent increase in gas prices over the same span, which would pinch incomes but would not be likely to create a recession.

The biggest concern, many economists say, is that the new mortgages have come onto the market at a time when low interest rates and rapidly rising home prices are the only reality many people can imagine. Families might be making decisions assuming that combination will last forever.

In a speech to bankers in New York, Donald L. Kohn, a Federal Reserve governor, said yesterday that he expected a strong economy over the next few years.

"My message this morning, however, is that this is not a time for complacency," he said.

There is "significant uncertainty," he added, because some recent financial innovations "have not yet been rigorously stress-tested."

NEWS: Regulators May Warn About New Mortgages

2005-06-17T07:06:00.000-07:00

Guidance Would Address Use of High-Risk Loans

By Kirstin Downey
Washington Post Staff Writer
Friday, June 17, 2005; D03

Federal banking regulators are preparing to warn lenders about the risks posed by the growing popularity of new kinds of adjustable-rate home mortgages that could leave borrowers facing steeper payments if interest rates rise or facing foreclosure if home values flatten or fall.

The Office of the Comptroller of the Currency, which regulates national banks, is considering a warning called a "guidance," which is a directive to lenders that would specify the kinds of loans and borrowers that would draw regulatory scrutiny because they are riskier. The OCC is reviewing interest-only loans that allow buyers to defer paying off the principal on the loan, as well as "option ARMs," or adjustable-rate mortgages that permit borrowers to decide how much to pay each month but leave them at risk of losing their homes if they do not pay enough.

These loans are proliferating in high-cost housing markets such as Washington, where buyers are using them to keep payments low enough that they can afford homes.

"We've noticed the rapid growth of interest-only loans and the growth of payment-option ARMs, and we thought it was worthy of more study," said Barbara Grunkemeyer, deputy comptroller for credit risk at the OCC. "We're doing our homework at this point to gain a better understanding" of how the loans are performing, she said. "We'll get something out on it, but not before the fall."

Grunkemeyer said the OCC is trying to distinguish where the mortgages are being marketed appropriately and where they are not. She said that the new kinds of mortgages were developed to meet the needs of "high-income, high-net-worth individuals who wanted to pursue other investment opportunities" and that they pose little risk when borrowers have substantial assets.

"The last thing we want to do is to come out with a half-baked guidance that puts a damper on a good product," Grunkemeyer said. She said the OCC is seeking to avoid a "knee-jerk reaction."

But she said the growth of the loans has raised concern because they "introduce new risk by shifting from the bank to the borrower more of the credit risk."

In congressional testimony last week, Federal Reserve Chairman Alan Greenspan said the "dramatic increase" in some of the newer kinds of loans raised "particular concern." Economists and housing experts have warned that some consumers who get these loans could find themselves confronting sharply higher monthly mortgages, leading to home foreclosures, which could become a costly burden to lenders if home values stagnate or drop.

"Our concern is [whether] people really comprehend the exposure they could face down the road when the payments change," said Jef Kinney, Fannie Mae's vice president for business and product development.

Government action could stall the rapid growth of interest-only and option ARM products, which have surged in popularity across the country. In the Washington area, more than a third of home buyers are using interest-only loans, up from about 2 percent five years ago.

Another popular new variant is the option ARM, which allows borrowers to decide how much they want to pay each month above a basic minimum but leaves them at risk of losing their homes if they pay less than the full interest due each month and find their mortgage balance increasing rather than falling. According to UBS AG, an investment banking firm, more than 50 percent of borrowers who took option ARM mortgages in 2004 are making minimum payments. Their mortgage balances are rising each month, which is called "negative amortization."

Regulator restrictions "would probably slow down the explosive growth of the market," said David Liu, a mortgage strategy analyst with UBS in New York. "The trend is very much unsustainable. If the government steps in, it would slow it down."

NEWS: Betting Against the House

2005-05-24T06:31:00.000-07:00

AHEAD OF THE TAPE
By JUSTIN LAHART

Wall Street Journal
May 24, 2005; Page C1

On Friday, Federal Reserve Chairman Alan Greenspan said that, although there are some signs of "froth" in the housing market with "a lot of local bubbles," the Fed doesn't see a bubble nationally. To many ears, that would seem like a moderate assessment.

News reports professing a housing bubble have become so frequent that James Bianco, head of investment-research firm Bianco Research, lists them in a section of his email to clients, dubbed "Your Daily Installment of 'Picking a Top in the Real Estate Bubble.' " Yesterday there were seven articles listed.

As for his take, Mr. Bianco thinks that bubbles don't end when everybody is screaming about how there is a bubble; the bubble pops when everybody has concluded that what has gone on with prices make sense.

In an online WSJ.com poll last week, 81% of respondents said they thought the U.S. housing market was in a bubble. Most of the people who responded "yes" thought the bubble would keep growing.

Such thinking can be dangerous, because often there isn't much of a step between believing that a bubble will continue and believing that not participating in the bubble will amount to lost opportunity. The late economic historian Charles Kindleberger pointed to Isaac Newton, who, convinced that price speculation in the South Sea Company had run too far amuck, sold off his shares for a profit in the spring of 1720. But he bought at higher prices later in the year, and suffered for it.

For those who would speculate in real estate, today's report on existing-home sales from the National Association of Realtors isn't likely to act as a deterrent. On average, economists expect an annualized 6.9 million homes came off the block in April, up from March's 6.89 million. Meantime, long-term interest rates have been falling -- yesterday the yield on the 10-year Treasury slipped to a three-month low of 4.07% -- giving would-be speculators the wherewithal to buy.

In the end, whether the housing boom is a bubble may matter less than the fact that the U.S. economy has become highly geared toward the real-estate market. Northern Trust economist Asha Bangalore points out that employment in housing and housing-related industries has accounted for 43% of the rise in private-sector payrolls since late 2001. If housing cools, what will take up the slack?

New Mortgage Guidelines Planned

2005-05-19T05:44:00.000-07:00

Regulators Fear Growth
In Offerings May Raise
Risk to Borrowers, Lenders

By RUTH SIMON and JAMES R. HAGERTY
Staff Reporters of THE WALL STREET JOURNAL
May 19, 2005; Page D2

Federal banking regulators, concerned about growing risks in the mortgage market, are planning to issue new guidelines for mortgage lenders.

The new guidelines, which could be completed as soon as early next year, come at a time of growing concern that the proliferation of new mortgage products could mean higher risks to borrowers and lenders. Regulators are turning their attention to mortgages after issuing their first-ever guidelines for credit-risk management for home-equity lending this week, warning financial institutions to re-examine their loan criteria.

NEWS: Fed Worries About Housing Bubble

2005-05-19T05:35:00.000-07:00

CAPITAL

By DAVID WESSEL

The Fed Starts to Show Concern

At Signs of a Bubble in Housing

May 19, 2005; Page A1

In the debate over whether the housing market is a bubble about to burst, the crowd that argues it isn't has been able to cite reassuring utterances by Federal Reserve officials. But there are proliferating signs that the housing market is looking a bit frothy. And now the U.S. central bank is beginning to worry more about it.

It isn't only that housing prices keep rising faster than almost anything else, up 10% on average nationally in 2004, according to the U.S. Office of Federal Housing Enterprise Oversight, and up 25% or more in the hottest markets in California, Florida and Nevada.

It isn't only that the clever mortgage industry keeps coming up with new ways to lend people money to buy houses that involve ever-more leverage and little -- or sometimes no -- down payment.

It's that more people are buying second and even third homes, expecting that prices will continue to rise so they can sell the houses quickly at a profit -- and that is drawing the Fed's attention. The National Association of Realtors says its surveys find that 23% of all homes purchased in 2004 were for investment, and a further 13% were vacation homes. It's as if Americans got tired of the stock market, and decided to look elsewhere to try to lose money.

For a long time, Federal Reserve Chairman Alan Greenspan dismissed suggestions that the U.S. was in the early stages of a housing bubble. He talked about the extraordinary demand for houses among hard-working immigrants. He emphasized that housing, unlike stocks, is a local market, so it's almost impossible to have a national housing bubble. He explained that it's hard to speculate in a house that you own because to sell it you have to move out.

But there has been a little more concern creeping into his commentary in the past few months. "We do have characteristics of bubbles in certain areas, but not, as best I can judge, nationwide," he told a House committee in February. Mr. Greenspan speaks to the Economic Club of New York at lunchtime tomorrow. If housing comes up in his remarks or if he is questioned on the subject by one of the prominent economists there, look for the Fed chairman to mention -- as Fed Governor Donald Kohn did recently -- the upturn in people buying vacation homes, second homes or other homes on the risky bet that housing prices will continue to rise as they have lately.

Mr. Greenspan hasn't yet hit the "irrational exuberance" gong, the phrase he used to warn about the stock market in December 1996. The Fed and other bank regulators, however, this week warned banks to take more care with home-equity loans, noting that such loans are "subject to increased risk if interest rates rise and home values decline." (Did you say decline? Gulp.) Even a slowing of the pace of increase in housing prices probably would dent consumer spending, which, for the past couple of years, has been helped by Americans tapping their home equity.

Other Fed officials have begun to express some anxiety. In a speech last month, Mr. Kohn said, "A couple of years ago I was fairly confident that the rise in real-estate prices primarily reflected low interest rates, good growth in disposable income and favorable demographics." Mr. Kohn was a longtime adviser to Mr. Greenspan before his appointment to the Fed board.

No longer. "Prices have gone up far enough since then relative to interest rates, rents and incomes to raise questions; recent reports from professionals in the housing market suggest an increasing volume of transactions by investors, who...may be expecting the recent trend of price increases to continue," Mr. Kohn said.

A surge in the number of people buying houses as a speculative investment is the contemporary equivalent of the story about Joseph P. Kennedy, father of the late president. According to the tale, he sold his stocks a week before the 1929 crash because he heard a shoeshine boy named Billy touting U.S. Steel and RCA. When the shoeshine boy starts giving you tips, he is supposed to have said, it's time to get out of the market.

The Fed, which contributed to the housing boom by keeping short-term interest rates so low for so long -- and encouraging the bond market to do the same with the long-term rates that determine mortgage rates -- doesn't expect a collapse of housing prices or an economic calamity. Mr. Kohn's worst case is "an erosion of real house prices" -- translation: an increase in house prices that falls short of the overall inflation rate -- "rather than a sudden crash."

Americans who have owned their homes for the past few years have a lot of equity in their homes: $9.62 trillion worth at the end of last year, up 13% from a year earlier, according to the Fed's tally. Even if house prices fall a bit, homeowners still will have significant equity -- except for those who have hocked nearly all the increase in home values with frequent refinancing or large home-equity loans.

But if house prices stop climbing, it won't be pleasant. Americans will feel poorer -- and they'll spend less as a result.

NEWS: Mortgage Risks

2005-05-17T05:25:00.000-07:00

Concerns Mount
About Mortgage Risks

Latest Data Show Move Toward
Alternative Loans Is More Pronounced
Than Previously Thought

By RUTH SIMON
Staff Reporter of THE WALL STREET JOURNAL
May 17, 2005; Page D1

In the latest sign of how frothy the housing market has become, new data show the degree to which people are stretching to buy homes in a hot housing market.

The data, from the Mortgage Bankers Association, show that adjustable-rate and interest-only mortgages accounted for nearly two-thirds of mortgage originations in the second half of last year. Both types of loans have helped fuel the strong housing market since they carry lower initial monthly payments than do fixed-rate loans, enabling borrowers to purchase more-expensive homes.

…

Though it has been clear that borrowers in high-priced markets have been gravitating to products that make homes more affordable, the shift has been greater than expected. In California, where home-price growth has been sizzling, interest-only loans accounted for 61% of the mortgages taken out to buy homes in the first two months of this year, up from 47.1% in 2004 and less than 2% in 2002, according to an analysis prepared for The Wall Street Journal by San Francisco researchers LoanPerformance, a unit of First American Corp. Just 18% of California households can afford to buy a median-price house using a conventional 30-year fixed-rate mortgage, according to a report issued this month by the California Association of Realtors.

…

The Mortgage Bankers Association conducted the survey of the interest-only and ARM share of mortgage originations in an effort to provide more accurate information about the housing market. The group's survey found that interest-only mortgages accounted for 17% of loans originated in the second half of 2004. And 46% of loans were adjustable-rate loans that don't carry an interest-only feature. The data reflect dollars lent, not the number of mortgages.

…

The MBA's weekly surveys -- which look only at application volume, not loans that are actually made -- had put the share of ARMs, including interest-only loans, at roughly 40% to 50% this year. That is up from as little as 18% of application volume in early 2003.

…

NEWS: U.S. Warns Lenders To Elevate Standards

2005-05-17T05:22:00.000-07:00

By Kirstin Downey
Washington Post Staff Writer
Tuesday, May 17, 2005; A01

Federal banking regulators yesterday warned banks and other lenders to be more selective about who can get home equity loans and lines of credit because rising interest rates may make it harder for people to repay their loans.

Government officials said that while mortgage defaults remain rare, many institutions are loading up on high-risk loans.

They urged lenders to review interest-only loans, which allow borrowers to delay principal payments for years, and "no-doc" loans, which don't require documenting borrowers' assets and income. They also suggested that lenders that refuse to do so may find themselves facing heightened federal oversight.

...

The regulators' warning came in what is called a "guidance" to the lending institutions, issued jointly by the Office of the Comptroller of the Currency, the Federal Reserve, the Federal Deposit Insurance Corp., the Office of Thrift Supervision and the National Credit Union Administration. They told the lenders they regulate that the institutions' "credit risk management practices have not kept pace with the products' rapid growth and easing of underwriting standards."

...

The regulators urged banks, thrifts and credit unions to use particular caution in making loans originated by mortgage brokers, who are not bank employees and who are paid by commission based on the volume of loans they complete.

"For control purposes, the financial institutions should retain appropriate oversight of all critical loan-processing activities, such as verification of income and employment and independence in the appraisal and evaluation function," the guidance said.

Similarly, lenders were also warned to be wary of loans purchased from financial institutions called "correspondents," which make loans on their own for resale to other lenders. Banking regulators noted that correspondents, too, "have an incentive to produce and close as many loans as possible."

Meanwhile, lending institutions should be monitoring the financial health of their home equity customers by periodically checking their credit scores, assessing the way people use their loans, monitoring home values in the neighborhood and using behavioral scoring to identify potential problem accounts. When such problems arise, lenders should refuse to extend additional credit or even reduce the credit limit available, the agencies said.
...
MORE
REPORT

REPORT: MORTGAGE MARKETS

2005-04-12T08:03:00.000-07:00

Office of Federal Housing Enterprise Oversight (OFHEO), 2004:

The U.S. economy ended 2003 on a sound note, having fully emerged from the recession that started two years earlier. However, the unemployment rate improved slowly as the year progressed. Early concerns about the sustainability of the recovery caused the Federal Reserve to ease monetary policy further in the first half of the year. Mortgage interest rates continued to descend, falling to the lowest level since Freddie Mac began tracking those rates in 1971. Commitment rates on fixed-rate loans averaged 0.7 percentage points below their level in the previous year.

The decline in mortgage rates sustained and strengthened the wave of mortgage refinancings that began in 2001, sending mortgage originations to a new high for the third consecutive year. Originations of single-family mortgages reached $3.8 trillion. The housing market achieved record levels of activity and contributed significantly to the economic recovery. On January 22, 2003, Freddie Mac announced that the Enterprise would restate its financial results for prior years. The restatement resulted in a cumulative increase in retained earnings of $5.0 billion and in regulatory core capital of $5.2 billion. Investigations by the Enterprise and OFHEO revealed substantial weakness in internal controls and inappropriate management of earnings. Several of Freddie Mac’s most senior managers were replaced, and extensive resources were employed in the restatement, but the Enterprise was able to continue its business functions throughout the year.

Both Freddie Mac and Fannie Mae reported strong financial results in 2003.1 The record level of mortgage originations enabled the Enterprises to achieve all-time highs in mortgage purchases and issuance of mortgage securities. Each Enterprise reported strong earnings despite sharp changes in interest rates. The Enterprises’ combined net income totaled $12.7 billion, while their combined net interest income rose 14.8 percent to $23.1 billion. The combined core capital of the Enterprises rose by $10.3 billion, more than keeping pace with growth in their outstanding business volumes. In addition, each Enterprise showed marked improvement in their fair value net worth. Strong earnings and higher capital enabled both Fannie Mae and Freddie Mac to meet their statutory minimum and risk-basedcapital requirements throughout 2003.

Full Report

Fed Study: Are Home Prices the Next Bubble?

2005-04-12T05:32:00.000-07:00

A close analysis of the U.S. housing market in recent years, however, finds little basis for such concerns. The marked upturn in home prices is largely attributable to strong market fundamentals: Home prices have essentially moved in line with increases in family income and declines in nominal mortgage interest rates.

Moreover, weaker economic conditions are unlikely to trigger a severe drop in home prices. Historically, aggregate real home prices have fallen only moderately in periods of recession and high nominal interest rates.

While such conditions could lead to lower home prices in states along the east and west coasts—areas where an inelastic supply of housing has made home prices particularly sensitive to changes in demand—regional price declines in the past have not had devastating effects on the broader economy.

Full Study

ACADEMIC: U.S. Household Debt Service

2005-04-01T11:05:00.000-08:00

Karen Dynan, Kathleen Johnson, and Karen Pence, of the Board’s Division of Research and Statistics, prepared this article. David Brown provided researchassistance.

Changes in aggregate household debt in the United States may contain information about the current state of the economy and may influence its future path. When a large share of household income is devoted to debt repayment, households have fewer funds available to purchase goods and services. Households with high debt levels relative to income are also more likely to default on their obligations when they suffer an unanticipated misfortune such as job loss or illness. Thus, when household debt ratios are high and unemployment is rising, lenders may respond to the expected increase in defaults by limiting the availability of credit; this dynamic may further
weigh on spending.

MORE

NEWS: GM's woes one more blow to housing bubble

2005-03-31T11:30:00.000-08:00

3/21/2005
Bill Fleckenstein, MSN Money

Along with Fannie Mae GM is a significant cog in the financing of the housing ATM. Why does that matter? Because last Wednesday, the yield on GM's debt widened to 454 basis points (4.54 percentage points) over Treasurys. In my opinion, it won't be much longer before that debt is downgraded. GM has been trying to finance autos, homes and second mortgages at record-low interest rates, but it's hard to see how the company can continue to do so.

MORE

BLOGS: Other Coverage that Can Provide Some Tid Bits

2005-03-30T13:26:00.000-08:00

Home Bubble
Housing Bubble
Curbed

NEWS: Japan's real estate still under bubble shadow

2005-03-29T13:45:00.000-08:00

www.chinaview.cn 2005-03-28 21:09:29
TOKYO, March 28 (Xinhuanet) -- Whereas land prices in large citiesacross Japan are picking up, the overall market is still on the decline, a lingering repercussion of the 1990s property foam, recent government statistics showed.
The statistics released last week by the Land, Infrastructure and Transport Ministry showed that the nation's average land prices dropped 5.0 percent in the year to Jan. 1, 2005 for the 14th consecutive year.
The residential land prices dropped 4.5 percent in the year, while that of land for commercial use fell 5.6 percent.
Compared with 1991 when the bubble economy started breaking, the residential land prices have dropped by 46 percent to the pre-bubble year of 1985, and the commercial land saw its prices shrinking by 70 percent to the lowest since 1974.

...In 1991 alone, the 12 leading banks poured 50 trillion yen (470billion US dollars) in loans into the property sector, a sum accounting for one-fourth of the total loans they gave in that year.

...The firms in the property and construction sector accounted forthe bulk of the bankrupt companies.
In 2000, some 6,000 such companies went broken, or 33.6 percentof the bankrupt businesses.
A total of 28 listed went bankrupt in 2002 with property firms taking up more than one-third, both setting a record after the World War II.

MORE

REPORT: The State of the Nation’s Housing 2004

2005-03-25T16:05:00.001-08:00

JOINT CENTER FOR HOUSING STUDIES OF HARVARD UNIVERSITY

Despite job losses in the rest of the economy, housing had another record-breaking year in
2003. Home sales, single-family housing starts, residential fixed investment, homeownership
rates, mortgage originations, refinances, and home prices all reached new peaks. The only
weak spots were the uneven rental market and the depressed manufactured housing sector.
MORE

ACADEMIC: 2003 Analysis of Housing Bubble

2005-03-25T16:05:00.000-08:00

Karl E. CaseWellesley College
Robert J. ShillerYale University
Is There a Bubble in the Housing Market?An AnalysisPrepared for the Brookings Panel on Economic ActivitySeptember 4-5, 2003

The popular press is full of speculation that we are in a "housing bubble" that is aboutto burst. Barrons, Money Magazine and The Economist have all run recent feature storiesabout the irrational runup in prices and the potential for a crash in home prices. TheEconomist has had a series of articles with titles like "Castles in Hot Air" "House ofCards" "Bubble Trouble," "Betting the House." These accounts have necessarily raiseda lot of concerns among the general public. But, how do we know if the housing marketis in a bubble?

The basic question is whether expectations of large future price increases aresustaining the market, whether these expectations are salient enough to generate anxietiesamong potential homebuyers, and whether there is sufficient confidence in suchexpectations to motivate action.

Housing Bubble May Be Global

2005-03-25T12:17:00.000-08:00

Long Term Demand for Housing is BIG

2005-03-25T12:11:00.000-08:00

TOWARD A NEW METROPOLIS:
THE OPPORTUNITY TO REBUILD AMERICA

Arthur C. Nelson
Virginia Polytechnic Institute and State University
A Discussion Paper Prepared for
The Brookings Institution Metropolitan Policy Program

Most American states and metropolitan areas have some idea as to the amount of growth
they expect over the next several decades, based on estimates of projected demographic,
household, market and industry trends. These estimates form the foundation of public policies and are vital for use in goal setting, planning, and implementation of a variety of growth and development However, there is not a general sense of how the projected changes in demographic, household, and market trends will impact our nation's built environment—that is, how many new homes, office buildings, and other physical structures will need to be built to accommodate future growth. To that end, this paper examines a series of projected trends at the national, state, and metropolitan level to determine the estimated demand for new housing, commercial, and industrial

In short, this paper finds that:
• In 2030, about half of the buildings in which Americans live, work, and shop will have
been built after 2000. The nation had about 300 billion square feet of built space in 2000.
By 2030, the nation will need about 427 billion square feet of built space to accommodate
growth projections. About 82 billion of that will be from replacement of existing space and
131 will be new space. Thus, 50 percent of that 427 billion will have to be constructed
between now and then.
• Most of the space built between 2000 and 2030 will be residential space. The largest
component of this space will be homes. Over 100 billion square feet of new residential
space will be needed by 2030. However, percentage-wise, the commercial and industrial
sectors will have the most new space with over 60 percent of the space in 2030 less than 30
years old.
• Overall, most new growth will occur in the South and the West. There is tremendous
variation in the total amount of buildings to be built between regions. In the Northeast, for
example, less than 50 percent of the space in 2030 will have been built since 2000, while in
the West that figure is about 87 percent, a near doubling of built space. Fast growing
southern and western places—states like Nevada and Florida and metropolitan areas like
Austin and Raleigh—will see the most dramatic growth.
• Though a small component of overall growth, the projected demand for industrial
space in the Midwest outpaces that of the other regions, unlike the other major land
uses. States with a strong industrial presence will see the largest amount of growth in
industrial space even though other areas may witness faster growth. After California, which
far outpaces the nation in terms of absolute square feet of new industrial construction, the
next four largest producers of industrial space are all Rust Belt states in the Midwest: Ohio,
Michigan, Illinois, and Indiana. By 2030, 70 percent of the Midwest’s industrial space will be
less than 30 years old.
• While these projections may seem overwhelming, they also demonstrate that nearly
half of what will be the built environment in 2030 doesn’t even exist yet, giving the
current generation a vital opportunity to reshape future development. Recent trends
indicate that demand is increasing for more compact, walkable, and high quality living,
entertainment, and work environments. The challenge for leaders is to create the right
market, land use, and other regulatory climates to accommodate new growth in more
sustainable ways.

Office Real Estate Bubble

2005-03-25T11:23:00.000-08:00

An reall good analysis by Grubb & Ellis screams bubble, but the author conclude that there is none, leading to a concern that they have a conflict of interests.

Retesting the Theory of Rational Exuberance in the Office Market, March 2004, Produced with PNC Real Estate Finance and Real Capital Analytics

Another earlier report by them is OK.

Myth or Reality?... Catching Up With the Office MarketOctober 2003Produced with PNC Real Estate Finance

Finally a more recent repot:
Is the Office Investment Market Ready to Implode?August 2004Produced with PNC Real Estate Finance and Real Capital Analytics

Fraud

2005-03-03T06:24:00.000-08:00

Sickened By Fraud, A Real Estate Appraiser Turns In His Pencil

by Blanche Evans,

"I have only practiced real estate appraisal in the state of Texas, but in my 53 years of being on this planet, without a shadow of a doubt, real estate appraisal is the most corrupt 'profession' I have ever seen," says a disgusted Burnitt. "It is my belief at this point it is no different in any other state."

[more]

Speculative buying in real estate rising

2005-03-02T09:00:00.000-08:00

A new study by the National Association of Realtors shows that 23% of all homes purchased in 2004 were for investment, while another 13% were vacation homes.

Yikes ! These numbers are national. I've seen reports that in areas of Florida and California as much as 70% of condo purchases are being done by people who never plan to live in their units.

Given that buying and selling homes are a lot more work than day-trading you would have thought this kind of speculation would be hard... That is what Greenspan was counting on last year. But this seem not to be true.

Some good reports

2005-03-01T08:43:00.000-08:00

This report looks at the office market and is very interesting approach to thinking about what is driving the bubble there. Strangely, the say there is no bubble but most of the report seems to point to bubble behavior in all parts of the market.
Bubble Re(W)rapped, Retesting the Theory of Rational Exuberance in the Office MarketMarch 2004

Separating the Boom from the Bubble

2005-02-03T12:34:00.000-08:00

The current discussion about the housing bubble has been largely based on data that is only partially appropriate, ignoring more important data and leading to more confusion than necessary.

Like many discussions about bubbles they overly rely on tracking rapidly rising prices. Rising prices may provide some initial warning signs but they are not sufficient for identifying a bubble.

Let’s address the fundamental question directly: We need to determine whether the growth in housing prices is due to a boom or a bubble.

A boom is based on rising prices based on growing investment opportunities that eventually level off. A bubble is based on an unsustainable rise in prices due to a cascade of bad investment decisions and/or speculative betting leading to a crash.

The data most frequently sited to warn that there is a housing bubble is the record high ratio of average home prices to average income.

This is used to argue that people cannot afford their homes given their income. However, mortgage interest rates are extremely low. As a result, home-buyers can afford homes that have far higher sticker prices because low interest rates make the monthly payments more affordable. It may take owners longer to payoff their mortgage, but that is a minor issue.

The price data alone cannot determine whether homebuyers are making bad or speculative buying decisions on housing that is not sustainable.

What we want to know is whether home buyers are purchasing homes that they cannot afford and at some point they will be confronted with this reality and prices will have to crash to come more in line with what the market can bear.

Homeownesrhip Burden Near Record High Stretching Homebuyers. The Federal Reserve Bank collects data that helps see this distinction. The Homeownership Burden calculates payments on mortgage debt, homeowners' insurance, and property taxes as a percentage of disposable income. Importantly, the focus then is on the actual payments homeowners need to make compared to what they can afford. This adjusts for the low interest rates.

At 9.86 percent, the Homeownership Burden is approaching the highest levels since data was first tabulated in 1980.

This reveals that from an historical perspective homebuyers are increasingly stretching themselves to buy a new home. It is not yet clear whether buyers have reached their limit. However, there are some substantial dangers ahead.

Adjusted Rate Mortgages at Record High in Rising Interest Rate Environment. Perhaps most worrying is that vast numbers of new mortgages being done as adjustable rate mortgages during this period of rising interest rates. Thus, the debt burden which has been increasing since 1998 due to high home prices, will now also start increasing even faster for homeowners due to rising interest rates.

If nothing else, these home buyers are taking on a lot of interest rate risk- especially because rates may rise faster than buyers anticipate.

Decline of Discipline. Some might expect that loan officers would play an important role in determining whether homebuyers can afford to carry their loans and would include the expected impact of rising rates. However, bubbles create intense competitive pressures to “win the deal,” and loan officers are not exempt from this pressure. In hot markets, loan officers that are not demonstrating high performance can be penalized.

The Federal Reserve conducts a survey of senior loan officers and asks them whether they are loosening or tightening their credit standards for mortgages to individuals.

Over the course of 2004, the Federal Reserve has reported that lenders have been substantially loosening their credit standards. In fact, a near record percentage of loan officers reported they were loosening their credit standards.

Speculative Activity Distorts Market Pricing and Accelerates Liquidity. There are also growing signs of speculative activity in the market. In the December FOMC meeting, the Federal Reserve noted this directly. Reports in California, Florida and other parts of the country indicate that as much as 70 percent of condominium buying and 15-20 percent of single family homes are being done by speculators who never intend to occupy their new homes.

Facilitating this speculative activity is the explosion of real estate investment clubs around the country and best selling books aimed at teaching individuals how to buy and sell homes.

The speculative activity alters two key factors in the market. First, it shifts the marketing pricing process from one where buyers are viewing homes as places to live and judging prices based on what they can afford to one where buyers are guessing how much others are willing to pay for them down the line in a hot market.
Second, speculative activity that brings in the general public adds vast amounts of capital to the market further adding to the inflationary pressures.

Given the pace of rising prices potential homebuyers increasingly fear that they may soon be priced out of homeownership altogether. Even if they believe that the market is a bubble, they may not be willing to take the risk that they are wrong and are jumping into the market. The psychological fear of rising prices is a classic cause of hyperinflation.

The perception of rising prices itself becomes self fulfilling prophecy. As more and more people buy now with the perception that they are avoiding higher prices later, they in fact they are causing higher prices. Buying now, appears to be buying at a substantial discount compared to the future when prices may 25-30 percent higher in one year. Correcting a hyperinflation syndrome is very difficult and usually ends in a significant crash.

FOR FULL REPORT WITH GRAPHS CLICK HERE

Some recent news items

2005-02-01T11:50:00.000-08:00

A record number of metro areas showed double-digit annual price appreciation in Q4., National Association of Realtors.

2004 Condo Sales Break Annual RecordExisting condominium and co-op sales set record for ninth consecutive year., National Association of Realtors.

Speculators Seeing Gold in a Boom in the Prices for Homes, New York Times

Real Estate Risks Are High According to New Study